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Ireland – Building on the fundamentals

We rarely divulge our investment strategy or go into detail on individual segments of a particular market unless we believe it warrants a Theme in itself. In this instance, we have recently expanded our Real Estate strategy in Ireland (Ireland – Time to Analyse the Fundamentals – 01/09/2012) with the launch of a new institutional Fund. This specific strategy will focus on opportunities within the multifamily/PRS property sector in in Ireland and in particular “Build-to-Rent” in Dublin.

 

In 2012, we discussed what we believed to be a generational opportunity in the Irish property market driven by significant macroeconomic analysis of both the economy and the Real Estate environment on a multi-year horizon. This thesis has come to fruition with both asset values and market rents recovering strongly. Many of the factors impacting our original view have either not been addressed effectively (supply versus demand across many sub sectors) or are continuing to show bullish signals (GDP growth, population changes, foreign direct investment, job creation, wage growth). At the time of writing, the Irish economy continues to show the highest GDP growth rate within the Eurozone.

 

Historically, the main driver of long-term Real Estate returns is income return; income return is, in turn, driven by GDP growth. If one can get in front of a countries strong growth rate then the next challenge is picking the right asset class and individual asset to best take advantage of this growth, therefore achieving significant alpha. In Real Estate, ‘Supply and Demand’ is generally the main push and pull that if analysed correctly, gives an investor the best opportunity to achieve outsized return.

 

It is well reported that Real Estate returns in Ireland have been exceptional in the last number of years. Our bullish outlook is no longer that of a general macro approach (in fact, we view some segments as over priced). As the market has normalised, it is imperative to be in the right sub-sector. We believe that Dublin residential asset prices remain significantly undervalued at the present time.

 

Research suggests that household size continues to decrease. The typical “millennial” rents for longer than previous generations and has less requirement to get on the property ladder as soon as possible (society has become more transient). Added to that, we have seen an institutionalisation of the residential asset class in the US over the past decade and this trend has been moving into mainland Europe over the last number of years. We take the view that a dedicated build-to-rent sector will emerge in Ireland over the medium term. Early signs are positive, with large quantities of NAMA stock sold to dedicated multi-family investors (Kennedy Wilson, IRES REIT etc.). However, these units were not designed as dedicated rental product as they were originally intended for individual sales so are somewhat inefficient and do not provide for the requirements of the modern day renter.

 

Dublin is in the midst of a perfect storm with regard to supply and demand economics. The low supply of residential assets remains at a critical level with construction and completions not yet delivering anywhere near the required levels to satisfy demand after years of zero completions. We expect (hope) that the Irish Government will introduce some form of measures and policies within the next year in an attempt to stimulate the market (i.e. legislative change, VAT holidays, speedier planning times, minimum standard alterations and other tax breaks).

 

The mix of a growing economy, demographic changes and a chronic residential supply shortage is resulting in ever increasing rents and it is likely that the cost of renting will increase beyond previous highs. Affordability issues could have an impact on rental growth beyond a certain level but our view is that wage growth is only now beginning to recover after years of stagnation and resolving the supply of housing stock is the only solution to ever increasing rents. At some point, a natural ceiling will be reached and simple economic history shows that markets will always find equilibrium when supply eventually catches up with demand.

 

 

The Rental Market

 

The Irish market prior to the banking crisis and resulting economic crash was typical of the Anglo-Saxon model of being dominated by the owner-occupier. However, since the financial crisis, the residential market seems to be moving towards a European rental model. This has been discussed previously and a number of reasons have been cited but core to this trend is the generational change whereby millennial’s value greater flexibility and lifestyle over the perceived security of home ownership. The old foundations of idealism towards home ownership (especially in Ireland) were corroded by the housing crash and the sight of a 60% drop in values and a whole generation remaining in negative equity. The other significant driver for rental properties taking an increasing share of the housing market is new mortgage rules being implemented to prevent another housing crash. The rule of thumb limits Loan-To-Value at 80% and a three times salary multiple. These stringent limits have meant that fewer people are able to enter the property market even if they wanted to – resulting in an increasing demand for rental accommodation.

 

Build-to-Rent

 

Ireland created a multifamily/PRS market by mistake in the wake of the financial crisis. The vast majority of residential developers went bust and Receivers/NAMA/Banks began renting the properties rather than implement the original business plan of individual unit sales in order to help service the existing loans during the crisis period. Once these assets were stabilised they were subsequently sold, typically in large portfolios to Private Equity funds during the three-year period between 2012 and H1 2015. This strategy proved extremely successful with significant increases in asset values as well as providing much needed housing for rental.

 

The ever-increasing demand for rental accommodation, the significant rental increases of recent years and projected future rental growth means that the need for purpose built residential accommodation managed by institutional investors/landlords is apparent. Being a “first mover” in the development and acquisition of purpose built rental accommodation (through our VERT brand) will help ease the current supply constraints and provide stable returns over a medium terms horizon as rental levels eventually reach an equilibrium, in this burgeoning institutional investment class. It is also an exciting period for Irish PRS as dedicated product brings a “new norm” to Dublin. Modern day renters are well travelled with high expectation and will continue to become more demanding. Our aim is to make renting feel like home through purpose built blocks, community living and amenity spaces.

 

This investment strategy focuses directly on demand dynamics but it should also “future proof” itself when increased supply comes online over the medium term. First generation rental stock that was never designed for a true PRS portfolio will become somewhat obsolete in comparison due to the lack of amenity offering and poorer (generally smaller unit size) quality of accommodation. These first generation assets will find it difficult to adapt as the majority of these portfolios consist of individual units within a larger block (i.e. not wholly owned). A lack of control for landlords will mean it becomes increasingly difficult to implement improvements or offer the greater amenities required to the more discerning renter.

 

We anticipate that this will create a two-tier market with the Build-to-Rent model being able to achieve higher income return over the medium/long-term while taking immediate advantage of the short-term supply and demand imbalance.

 

This is likely to be a multi-year theme as the supply lag to satisfy the demand remains a significant challenge and the Build-to-Rent sector will be a significant beneficiary over all time horizons.

 

 

 

 

Some quick figures which we find interesting…….

 

1. DEMAND

 

GDP

 

GDP growth in Ireland is the strongest within the Eurozone and is projected to remain the fastest growing economy throughout 2016 and 2017.

  • 2014: GDP growth of 4.80%;
  • 2015: GDP growth of >5.00% (actual 7.80% – SW3 UPDATE Q1 2016);
  • 2016 and 2017: Central Bank forecasts of 5.10% and 4.20% respectively;

EMPLOYMENT

 

  • Employment growth has been on a consistent upward trajectory since the lows seen in 2012 when unemployment stood at 15% and will have fallen below 9.00% by the end of 2015.
  • We expect unemployment levels to drop a further 100 basis points during 2016 while the Government is projecting to secure ‘full employment’ by 2018.

DEMOGRAPHICS

 

  • 4.59 Million (2011 Census)
  • 1.275 million (Dublin) which is an increase of >7% from previous Census in 2006;
  • In 2014, Ireland had both the highest birth rate and lowest death rate in the Eurozone:
    • 14.4 per 1,000 people (10.1 per 1,000 is EU average);
    • 6.4 per 1,000 people (9.7 per 1,000 is EU average);
    • Growth rate in Ireland is therefore 8.1 per 1,000 people;
    • One in three people are currently under the age of 25.
    • It is expected that the population in Dublin will increase by a further 10% prior to 2022. To satisfy the resulting housing demand, Dublin requires an additional 12,000 units for each of the next seven years (ESRI). To put the supply shortage into perspective, less than 3,000 housing units were built in 2014 after seven years of almost zero builds and no real improvement anticipated in the final 2015 data set.
    • With population growth set to increase by 600,000 between now and 2031, the Construction Industry Federation (CIF) state that 60% of that number (360k) will need to be accommodated in the greater Dublin area. Like many other countries, the urbanisation trend looks set to continue with rural areas seeing mass migration to Dublin (and a lesser degree Cork/Galway).

 

2. SUPPLY

 

  • The Government Housing Agency estimates that Ireland needs 22,000 homes to be built every year in order to match annual demand. This does not include the chronic under-supply that is now in place due to no new building between 2006 and 2013. Out of this 22,000 total, it is estimated that Dublin requires >12,000 new homes annually. However, housing completion figures from the Department of the Environment for the first nine months of this year show fewer new homes were built across Dublin city and county than in the same period last year, down to 2,057 from 2,403;
  • In 2006 (the height of the construction boom), 66,470 homes were built in the first nine months of year, 14,375 of which were in Dublin;
  • The drop in the number of homes completed this year in Dublin is down to a particularly poor performance in two local authority areas – Dublin City and South Dublin;
  • In South Dublin City, which the Housing Agency says has the greatest need for new homes, just 494 new houses and apartments are anticipated in 2015, more than one third fewer than in the same period last year. South Dublin saw an even steeper decline, a drop of 60% from 582 homes built down to just 231 (to Q3 2015).