Irish Property - FINFACTS · Irish Property A detailed updated view on the prospects for the sector...

September 2014

Irish property still in the early stages of recovery Supply shortages to propel rents and prices higher Construction sector is responding, albeit with a lag

EconomistsDermot O’LearyT +353 1 641 9167 E [email protected]

Juliet TennentT +353 1 641 9469 E [email protected]

Goodbody Stockbrokers, trading as Goodbody, is regulated by the Central Bank of Ireland. For the attention of US clients of Goodbody Securities Inc, this third-party research report has been produced by our affiliate Goodbody Stockbrokers. Please see the end of this report for analyst certifications and other important disclosures.

Irish PropertyFrom stabilisation to recovery

Robert Eason, Head of Research+353 1 641 9271 [email protected] and CreditEamonn Hughes+353 1 641 9442 [email protected] Foley+353 1 641 6042 [email protected] Simpson+353 1 641 0478 [email protected] Diskin+353 1 641 9193 [email protected] Materials/Paper and PackagingRobert Eason +353 1 641 9271 [email protected] O’Brien+353 1 641 9230 david.a.o’[email protected] Reilly+353 1 641 6080 [email protected] McDermott+353 1 641 0482 [email protected] and BeverageLiam Igoe+353 1 641 9450 [email protected] Higgins+353 1 641 0403 [email protected] Matthews+353 1 641 9187 [email protected] Hennigan+353 1 641 9274 [email protected] Higgins+353 1 641 0403 [email protected]/MediaGavin Kelleher+353 1 641 0423 [email protected] Cairns+353 1 641 9162 [email protected] Services/TechnologyColm Foley+353 1 641 6042 [email protected] O’Leary+353 1 641 9167 [email protected] Tennant+353 1 641 9469 [email protected] BrokingLinda Hickey, Head of Corporate Broking+353 1 641 6017 [email protected] Hodgson+353 1 641 9216 [email protected] Gill+353 1 641 9449 [email protected] Kelly+353 1 641 9435 [email protected] Wyley +353 1 641 6070 [email protected]

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report for analyst certifications and other important disclosures.

Irish Property A detailed updated view on the prospects for the sector

From stabilisation to recovery

Economic Research 02 Sep 2014

Recovery still in the early stages

Irish property has been among the best performing asset classes in the world over

the past twelve months. Despite the significant price growth already seen, growing

supply/demand imbalances lead us to believe that Irish property is only in the

early stages of recovery, with significant growth in rents and capital values

expected over the medium-term.

Rental growth to be the key driver of commercial property returns

Commercial property yields remain attractive relative to government bond yields

despite the significant declines over the past twelve months. While further yield

compression is likely in our view, the biggest driver of returns in the Irish

commercial property market is expected to come via rental growth. The current

boom is the fourth since the early 1980s and is reflective of the highly cyclical

nature of the commercial property space.

Boom in office rents reflects development lags

Our historical analysis of cycles in the Dublin office market suggests that rental

growth peaks 1-2 years prior to the peak in new office supply. With a recovery in

office completions only likely to reach an embryonic stage in 2016, supply

shortages, particularly in CBD, will propel rents significantly higher over the

coming years. From a trough of €320 per sqm, we expect prime Dublin office rents

to surpass the €670 per sqm peak levels by 2018.

Residential prices close to fair value, but supply shortage to push prices

higher

The price recovery in the residential sector is exactly in line with historical

experience despite some fears of another bubble. On a national basis, valuation

metrics suggest prices are close to fair value. Growing supply shortages in the

Dublin area will mean that the capital will continue to lead the price recovery, but

we expect a further broadening across the country. It is not yet a “quality”

recovery, with transaction levels, new supply and mortgage lending still below

“normal” levels.

Supply response is coming, but not quickly enough

The scale of Ireland’s crash has impacted on the construction industry’s capacity to

recover. Finance is restricted, balance sheets are fragile and projects have only

recently begun to make economic sense due to the extent of the fall in prices and

the relative stickiness of costs. We expect impressive growth in construction

activity over the coming years, as development recovers, but inevitable lags mean

this response will not be quick enough to stall large price rises. Market forces will

help but both Government and industry-level efforts will also be required to kick-

start development in the sector.

0

50

100

150

200

250

300

Dec-

70

Dec-

74

Dec-

78

Dec-

82

Dec-

86

Dec-

90

Dec-

94

Dec-

98

Dec-

02

Dec-

06

Dec-

10

Dec-

14 (f)

Dec-

18 (f)

Index (

1970=

100)

Source: Lisney *deflated by CPI

Real office rents* (1970-2018f)Type title hereType title hereReal office rents* (1970-2018f)

0

2

4

6

8

10

12

14

16

18

20-30

-20

-10

0

10

20

30

1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

(Q2)

Office rental growth (LHS) Completions/stock (RHS, Inverted)

Supply peaks follow rental growth

Source: IPD, Lisney, Goodbody

Peak rental growth=1989

Peak rental growth=2000

Peak rental

growth=2007

Supply peak=1991

Supply peak=2001

Supply peak=2008

0%

10%

20%

30%

40%

50%

60%

70%

National Dublin "International

recoveries"* - 5 years

after trough

% o

f price d

rop r

ecovere

d

Residential price recovery has some way to go

Source: CSO, Goodbody *sample of 10 recoveries after large price falls

Current

End-2016 (4 years after trough)

Economists

Dermot O'Leary

+353-1-641-9167

[email protected]

Juliet Tennent

+353-1-641-9469

[email protected]

Goodbody

Page 2 02 Sep. 14

Key themes

In September 2013, we stated that a new cycle had begun in the Irish property market and that better

times lay ahead for the sector (see Foundations of recovery, 27 September 2013). Since then, Irish

property has been one of the best performing asset classes in the world, propelled by tightening supply,

particularly in the capital, and a broadening economic recovery. In this report, we update our analysis of

the sector and explain our current thinking. Based on a growing imbalance between supply and demand,

we believe that further significant growth in rents and prices will occur over the coming years and that

the sector is still at the early stages of price recovery.

Recovery well established, but still in the early stages

The Irish property cycle has moved from collapse, to stabilisation, to recovery over the last

24 months. Having been one of the best performing asset classes in the world over the past

twelve months, bargain basement prices are now a thing of the past. Over this time period,

Irish commercial property achieved returns of 26%, residential prices grew by 13% (+23%

in Dublin), while residential rents grew by 8% yoy (+17% yoy in Dublin City). Despite this

growth, we believe that the property cycle is still in the early stages of recovery.

From an investment perspective, the current and expected supply/demand conditions bode

well for returns over the medium-term. From an economic perspective, one could describe

this as “an uncomfortable boom” because we have not yet seen a supply response

commensurate with the growing demand that the sector is experiencing. For instance, house

building is running about a third of fundamental medium-term demand, while there are no

new offices expected to be completed to any meaningful extent until 2016/2017. With

demand conditions (employment, office take-up, and economic growth) strengthening,

supply shortages are emerging, particularly in the capital, pushing up prices. Issues such as

funding and capacity are at fault for the tardy response of the construction industry, but

property markets are rarely in equilibrium due to development lags in any case.

Economy strengthening and broadening

Domestic demand is expected to make a contribution to economic growth in 2014 for the

first time in seven years. The recovery in domestic demand continues to be led by a strong

rebound in investment spending with particular dynamism in construction and in machinery

and equipment investment. Dublin will continue to lead the recovery due to the continued

flow of FDI and foreign capital in particular. However, the recovery is broadening, with

growth in employment being the most impressive confirmation of this.

Supply shortages to propel office rents significantly higher

Ireland is in the midst of its fourth commercial property price boom in the last thirty years.

While all have different features, the anatomy of each is similar, with the development lags

being the most important consideration. In line with historical experience, yields have fallen

in the expectation of future rental growth. Despite this fall, commercial property yields

remain attractive relative to government bond yields. While further spread compression is

likely, returns will predominately come from rental growth over the coming years.

Historical analysis suggests that office rental growth peaks 1-2 years ahead of the peak in

new supply. While there have been early signs of a recovery in development, the first batch

of new offices will only trickle on stream in 2016, after a five year drought. In the meantime

vacancy rates will continue to fall, having fallen significantly from the peak already, thus

putting further upward pressure on rents.

Goodbody

02 Sep. 14 Page 3

Residential property

Dublin continues to lead the recovery in the residential property market. However, recent

trends confirm that the market is now also firmly in recovery mode outside the capital.

Significant differences remain across the country in terms of supply and demand. Any view

of the Irish property market must take these into account.

There has been some speculation about another bubble in Irish house prices, but our

analysis of international property recoveries suggest that the current Irish one is typical,

albeit coming from a lower base than the average. Residential yields still remain attractive

relative to government bonds while our house-price/income metric analysis suggests prices

are now close to fair value. Transactions levels have improved from the bottom but remain

below “normal”. Similarly, new mortgage lending is expected to grow strongly this year

(+50%), but remains below the level where we would describe the recovery as a quality

one.

Supply overhangs still exist in parts of the country, while supply shortages exist in the

Greater Dublin area. Over the medium-term, these supply overhangs will be worked

through, and with a growing population and falling household sizes, we estimate that

medium-term housing demand amounts to 27,000-36,000 units per annum.

Construction response has been slow due to many issues…

The supply response to the recovery in property prices has been surprisingly muted to date,

although there are early signs of recovery. We attribute this tardy response to a number of

factors. Firstly, funding for the sector remains constrained by a banking sector which is

understandably more cautious about lending into the sector following a record crash.

Secondly, the capacity of the construction sector is constrained by stretched balance sheets

and the migration of resources due to the record-long recession in the sector. Thirdly,

planning delays continue to be a constraint. Finally, NAMA, still the most important property

player in the country, has only recently unveiled its plans to play a role in the rehabilitation

of the sector.

…but significant output growth is expected over the medium term

Despite these constraints, we still believe that market forces (i.e. higher prices) will lead to

significant growth in the construction sector over the coming years. In 2013, construction

amounted to just 7% of GNP, relative to a long-term average of 13%. This is currently the

lowest in the EU. Measures contained in the Government’s recent Construction 2020 strategy

document will help to revive the sector, but we do not believe there is any magic bullet. We

believe the construction sector will return to a normal size of 11% of GNP by the end of the

decade. This implies output growth averaging 11% per annum over this period.

Goodbody

Page 4 02 Sep. 14

Contents

Executive Summary .................................................................................................. 1

Key themes.............................................................................................................. 2

Introduction ............................................................................................................ 5

Macro-economic backdrop ....................................................................................... 6

Commercial Property ............................................................................................... 9

Irish performance a global standout ............................................................................ 9

An analysis of cycles in the Irish property market ....................................................... 13

Stages of a cycle: The market is rarely in equilibrium .................................................. 15

Market cycles and the Dublin office market ................................................................ 16

Recent office market dynamics ................................................................................. 17

What will the vacancy rate fall to? ............................................................................ 19

Retail sector – early signs of recovery emerging ......................................................... 22

Industrial – rents climbing from low levels ................................................................. 23

Residential property .............................................................................................. 24

The recovery is in its early stages and tracking previous international cycles .................. 24

The market is not yet functioning properly ................................................................. 31

The Construction Sector – mean reversion expected ............................................. 33

What is holding back construction activity? ................................................................ 34

The Construction 2020 strategy ................................................................................ 35

Goodbody

02 Sep. 14 Page 5

Introduction

After experiencing the most spectacular crash in the developed world in the post-Lehman period, the

Irish economy in general and the Irish property market in particular has been at the top of investors’

locations to “buy the recovery” over recent years. Those investors have been rewarded handsomely for

their belief, with Irish-exposed investments such as sovereign bonds, equities and, in particular,

property performing extremely well over the past twelve months.

In our report on the Irish property market last year (Foundations of Recovery, 27 September 2013), we

made the call that Irish property had begun a new cycle that would see a continued recovery in rents

and capital values. Since then, the recovery in property has been swift and broad. The office sector has

led the way, providing a total return of 33% over the past twelve months. Commercial property returns

overall, though, at 26.6% have been very impressive, with capital values now also growing in the retail

and industrial sectors. Residential prices, led by Dublin, have also experienced a sharp rebound.

Given the speed of the turnaround, some have questioned the sustainability of the recovery in the

property market. Our analysis shows that the recent rebound must be put in the context of: (i) volatile

property cycles have been par for the course, not just in Ireland, but internationally for decades; (ii) the

recent rebound is coming after an exceptionally severe downturn; (iii) various supply constraints have

resulted in a situation where prices are being squeezed upwards by an ongoing imbalance between the

supply and demand for property, and; (iv) an international “search for yield” has been in train due to the

low level of government bond yields.

Ireland’s property recovery has moved on to a new phase. Given the scale of competition for Irish

property assets, valuations have indeed been bid up and the market has moved beyond the distressed

phase. Our view though is that rental growth will continue to remain strong in both the residential and

commercial property spaces. Dublin retains the most attractive demand characteristics, but has also

seen the most intense competition for investment.

Irish property in historical context

Source: CSO, DoELG, IPD, Goodbody

0

50

100

150

200

250

300

350

400

450

1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016f

Index (

1983=

100)

GDP Housebuilding Comm property prices (real) Resi prices (real) GNP

Real commercial

property prices still

below 1983 levels

Housebuilding at record lows

Goodbody

Page 6 02 Sep. 14

Macro-economic backdrop

Recovery has moved up a gear

The Irish economy is in the midst of a cyclical recovery that is being led by strong growth in investment

spending. This rate of expansion and the momentum seen in the PMI surveys through the first half of

2014 surprised to the upside, giving us the justification to raise our economic growth forecasts recently.

We now forecast that the Irish economy will grow by over 3% on average over the 2014-2016 period.

The expansion is becoming increasingly broad-based, with domestic demand to make a contribution this

year for the first time since 2007. Indeed, core domestic demand (i.e. excluding aircraft and R&D) has

strengthened significantly over recent quarters and in Q1, grew by 3.4% yoy in Q1.

Domestic demand growth has strengthened significantly in recent quarters

Source: Goodbody, CSO

The recovery in domestic demand continues to be led by a strong rebound in investment spending with

particular dynamism in construction and in machinery and equipment (+50% yoy in 2013). The chart on

the next page shows the surge in business investment spending over the past four quarters, while

surveys from employers’ groups and the bank lending survey indicate that further strength is likely in

the coming quarters.

While investment continues to lead the recovery, the latest evidence suggests that a modest recovery in

consumption is also in train. The improvement in the labour market is the biggest contributor to this, but

consumer confidence has also been rising, and disposable income has finally stabilised. However, the

high level of debt carried by Irish households will curb spending so the recovery will be modest over the

next three years.

-6%

-4%

-2%

0%

2%

4%

6%

8%

Q1 11 Q4 11 Q3 12 Q2 13 Q1 14

YoY

Domestic Demand DD (less planes & R+D)

Goodbody

02 Sep. 14 Page 7

Consumer spending has stabilised

Source: Goodbody

Business investment has surged

Source: CSO

On the external side, the latest data suggests that the worst effects of the patent cliff may be behind us.

While we are loath to make a conclusive call on this issue, goods exports did bounce back in the first

quarter of the year, while services exports continued their positive performance. After a poor 2013, net

exports will once again make a positive contribution in 2014.

Ireland has also had a few favourable statistical “bounces of the ball”. These have seen both the drag

from the fall in output in Q4 2013 revised away, and upward revisions to GDP have helped the aesthetics

of Ireland’s debt and deficit ratios. Owing to these revisions and the outperformance of tax revenues, it

appears that, after seven years of austerity, the 3% deficit target is achievable in 2015 without any

additional measures.

GDP also experienced a large increase of 2.7% qoq on a seasonally-adjusted basis in Q1, meaning that

even a flat quarterly profile for the remainder of the year would result in a 3.7% increase for the full-

year. However, due to the volatility of the data and the incidence of revision, we prefer to look at the

data on an annual basis. In Q1, there was broad-based growth in all expenditure components, leading to

a 4.1% yoy increase in GDP and a 3.4% yoy increase in GNP.

Large Q4 2013 drop in GDP revised away…

Source: CSO

…while annual growth bounced in Q1 2014

Source: CSO

Irish growth forecasts

2012 2013 2014f 2015f 2016f

Consumption -1.2% -0.8% 1.4% 1.7% 1.9%

Government -2.1% 1.4% -0.4% -0.5% 0.4%

Investment 5.0% -2.4% 10.9% 10.2% 8.4%

Dom Demand -0.2% -0.7% 2.9% 3.1% 3.1%

Exports 4.7% 1.1% 4.7% 4.0% 3.6%

Imports 6.9% 0.6% 4.6% 3.4% 3.3%

GDP -0.3% 0.2% 3.5% 3.6% 3.4%

GNP 1.9% 3.2% 3.8% 3.6% 3.4%

Source: CSO, Goodbody

19

20

20

21

21

22

22

23

23

Q106

Q206

Q306

Q406

Q107

Q207

Q307

Q407

Q108

Q208

Q308

Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Q412

Q113

Q213

Q313

Q413

Q114

Eu

r(b

n)

per

qua

rte

r

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

2005Q

2

2005Q

4

2006Q

2

2006Q

4

2007Q

2

2007Q

4

2008Q

2

2008Q

4

2009Q

2

2009Q

4

2010Q

2

2010Q

4

2011Q

2

2011Q

4

2012Q

2

2012Q

4

2013Q

2

2013Q

4

YoY (

4-q

uart

er

tota

ls)

Core business investment Construction investment Total investment

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

Q4

2013

Q1

2014

QoQ

change (

s.a

)

Old New

-4%

-2%

0%

2%

4%

6%

8%

10%

Q1

11

Q2

11

Q3

11

Q4

11

Q1

12

Q2

12

Q3

12

Q4

12

Q1

13

Q2

13

Q3

13

Q4

13

Q1

14

YoY (

%)

GDP GNP

Goodbody

Page 8 02 Sep. 14

Dublin continues to dominate

The recovery continues to be driven by the main urban centres in Ireland, particularly Dublin. This is

highlighted by the variation in unemployment rates across the country. From having an unemployment

rate close to the average for the State just before the financial crisis in early 2008, Dublin now has the

lowest unemployment rate at 10%, lower than the 11.8% country average and more than four

percentage points below the highest rate of 14.3% in the South East.

This continues to be driven by Dublin’s relative attractiveness as a business location for foreign direct

investment, which in turn has been the driver of the Irish recovery. Figures from the Dublin Regional

Authority bear this out with almost 50% of all IDA (the agency responsible for attracting foreign

investment) companies located in Dublin. The urban centres of Cork, Galway, Limerick and Waterford

only account for a combined total of about 25%. This split is likely to continue as Dublin benefits from

the “cluster” effect of similar types of industry locating together, infrastructure, an educated workforce

and its ability as the largest city in the country to attract and retain additional suitably qualified

employees.

Dublin has the lowest unemployment rate in the country

Source: CSO

0

2

4

6

8

10

12

14

16

Dublin

Mid

-East

South

-West

Sta

te

Bord

er

West

Mid

-West

Mid

land

South

-East

Unem

plo

ym

ent

rate

%

Q2 14 Q1 08

Goodbody

02 Sep. 14 Page 9

Commercial Property

Irish performance a global standout

Investment returns in the Irish commercial property market have been stellar over the past twelve

months. According to Investment Property Databank (IPD), Irish commercial property delivered a total

return of 26.6% in the twelve months to Q2 2014, with quarterly growth accelerating for the last three

quarters. The chart below puts this performance in the context of a range of asset classes across the

globe. While total returns in the equity market have been similar over the past twelve months, returns in

the year to date have been far superior in Irish property.

Irish property performance in context – Total Return - 12 months to Q2 2014

Source: Bloomberg, FactSet, Goodbody

Looking at the performance of Irish commercial property in more detail, the following table shows that

the office sector has led the way in terms of both rents and capital values. In the portfolio of IPD

properties, office rents have grown by 22% in the past year, relative to 12% for commercial property

overall. Office capital values have grown even more substantially (33%), thanks to the ongoing fall in

yields.

Irish commercial property returns summary

Total Return Capital Growth Rental Growth

Quarterly Change Q4-13 Q1-14 Q2-14 Q4-13 Q1-14 Q2-14 Q4-13 Q1-14 Q2-14

Total 5.8% 7.2% 8.5% 3.6% 5.0% 6.5% 3.6% 1.0% 6.9%

Office 7.3% 8.4% 10.1% 5.0% 6.2% 8.2% 7.0% 2.1% 11.0%

Retail 4.1% 5.8% 6.0% 2.1% 3.9% 4.2% -1.0% -0.7% 0.0%

Industrial 3.6% 3.0% 4.5% 0.6% 0.0% 1.7% 0.3% -0.6% 0.1%

Annual Change

Total 12.9% 19.4% 26.6% 3.3% 9.6% 16.7% 2.3% 3.5% 11.5%

Office 18.3% 25.1% 33.0% 7.9% 14.7% 22.7% 7.7% 9.8% 21.9%

Retail 6.2% 12.6% 18.8% -2.0% 4.2% 10.2% -5.9% -5.6% -3.5%

Industrial 9.6% 10.9% 13.7% -2.4% -1.3% 1.4% 3.2% 1.0% 0.2%

Source: IPD

0%

5%

10%

15%

20%

25%

30%

Alternatives Commodities Euro bonds Euro high-

yield

Stoxx600 S&P 500 Irish property

12 m

onth

s t

o Q

2 2

014

Goodbody

Page 10 02 Sep. 14

The pattern of the cycle of recent years has been a typical one:

After falling substantially over the credit-fuelled boom years, yields rose sharply in a relatively

short period of time; the equivalent yield for Irish commercial property overall rose from a low

of 4.0% in Q4 2007 to 8.3% just two years later triggering a substantial fall in capital values

Rents started falling in Q1 2009

Due to a combination of the European sovereign crisis, Ireland’s entry into an IMF programme

and uncertainty about the abolition of upward-only rental reviews, yields rose again in 2011

and 2012, peaking at 8.9% on an equivalent yield basis in Q2 2012.

The equivalent yield has since fallen to 7.3% owing to strong interest in the Irish economy and

property, a search for yield internationally and expectations of rental growth.

Rents fell for nineteen consecutive quarters before eventually stabilising and starting to

increase in Q4 2013, more than a year after start of the yield decline.

Yields still falling after sharp increase

Source: IPD

Rental growth has recently followed

Source: IPD

Values supported by the economic environment

As already described, the economic recovery has strengthened and become more broad-based over the

past twelve months and supported the recovery in commercial property. Twelve months ago, we were

anticipating domestic demand growth of 1.5% in 2015, but now our forecasts are for growth of 3.1%.

Commercial property correlated with the economic cycle

Source: CSO, IPD, Goodbody

3

4

5

6

7

8

9

10

Yie

ld (

%)

Equivalent yield Reversionary yield

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

% Q

oQ

-10%

-5%

0%

5%

10%

15%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Commercial capital values (LHS) Domestic demand (RHS)

Goodbody

02 Sep. 14 Page 11

Yields remain attractive

The fall in commercial property yields over the past twelve months must be seen in the context of a fall

in the yields on Irish and, indeed, international assets over the same time period. According to IPD, the

equivalent yield on Irish property fell from a peak of 8.9% in Q1 2013 to 7.3% in Q2 2014 (the

reversionary yield on this portfolio of properties is estimated at 6.4% in Q2 2014). Over that same time

period, the yield on Irish ten-year government bonds has fallen from 4.3% to 2.7%, while the current

ten-year yield stands at just 1.8%. On a relative basis, therefore, Irish commercial property yields

remain high. While it is our view that government bond yields will rise over the coming years, there is

scope for a further reduction in the spread in the short-term.

Spread of commercial yields to government yields still at historical highs

Source: IPD, Factset, Goodbody

The IPD portfolio represents a diverse range of properties. Due to this, issues such as over-renting,

varied unexpired terms, quality and location can make the analysis of underlying yield movements

somewhat more difficult. It is helpful, therefore, to complement this analysis with the equivalent yield

series published by the various commercial property agencies. We have reproduced the series published

by CBRE on the next page.

Since the publication of our property note a year ago, yields have fallen across the board. In the retail

sector, prime city centre yields have fallen from 5.75% to 4.75%, but are still well above boom levels.

Prime office yields stood at 6.25% a year ago, but there are now some early indications of deals being

struck at yields of below 5%. Finally, prime industrial yields in Dublin have fallen from 8.75% to 8.0%.

CBRE believe all categories of commercial real estate assets continue to trend stronger.

-10

-5

0

5

10

15

20

1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

(Q2)

%

Gov. Equiv. yield Revers. yield Spread Average spread

Goodbody

Page 12 02 Sep. 14

CBRE Equivalent Yield Series (%)

Peak Jul-13 Dec-13 Mar-14 Apr-14 May-14 Jul-14 Trending

Retail

Shops

Prime High Street 2.50 5.75 5.50 5.25 5.00 4.75 4.75 Stronger

Good Secondary High

Street 3.50 7.00 6.75 6.25 6.00 6.00 5.80 Stronger

Prime Provincial High

Street 3.25 8.00 7.75 7.25 7.25 7.25 7.00 Stronger

Shopping Centres

Prime 3.50 7.50 7.00 6.75 6.50 6.50 6.50 Stronger

Secondary 4.25 9.50 9.25 8.75 8.75 8.50 8.50 Stronger

Retail Warehouses

Prime 4.25

7.25 7.00 7.00 7.00 6.50 Stronger

Secondary 5.00

10.00 10.00 9.50 9.50 9.25 Stronger

Offices

Prime City Centre

Dublin 3.75 6.25 5.75 5.25 5.00 5.00 5.00 Stronger

Secondary City

Centre Dublin 4.25 7.50 6.75 6.00 5.75 5.75 5.75 Stronger

Suburban Dublin 5.00 8.50 8.00 7.00 6.75 6.75 6.75 Stronger

Prime Provincial 5.75 9.50 9.00 7.75 7.75 7.75 7.50 Stronger

Industrial

Prime Dublin 4.75 8.75 8.25 8.00 8.00 8.00 8.00 Stronger

Secondary Dublin 4.75 10.75 10.50 10.25 10.25 10.25 10.25 Stronger

Prime Provincial 5.75 12.00 11.00 11.00 11.00 11.00 11.00 Stronger

Source: CBRE

Investment volumes will exceed 2006 peak in 2014

Investment in Irish commercial property has increased dramatically over the past 2 years. 2012 saw a

huge increase on the miniscule level achieved in 2011, but this level had been surpassed by the end of

H1 2013. By the end of 2013, the total investment in Irish real estate reached over €1.9 billion. 90% of

this occurred in Dublin, while office sales accounted for 60% of the value transacted. Momentum has

continued into 2014, with €1.6bn in deals transacted in H1. It is likely that transactions for the full-year

will exceed the €3bn peak achieved at the time of the last boom in 2006.

Irish real estate investment flows

Source: Savills

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014f

€bn

Goodbody

02 Sep. 14 Page 13

An analysis of cycles in the Irish property market

Fortunately, Ireland has one of the longest time series on commercial property in the IPD dataset. From

it, we can see very distinct commercial property cycles. From a returns perspective, the Irish commercial

property market is in the midst of its fourth boom period in the last thirty years. The most recent boom

follows the biggest bust in history.

Irish commercial property cycles – 1984-2014

Source: IPD

The following table illustrates the characteristics of these cycles in more detail. A few lessons can be

taken from these periods:

1. Cycle length: We define a “boom” period as consecutive years where total returns are in

excess of 5% per annum. On this basis, Boom 1 and Boom 3 last five years, while Boom 2,

coinciding with the most impressive period of growth in Ireland’s economic history lasted eight

years.

2. Rising tide lifts all boats: Cycles are remarkably similar across the different categories of the

commercial property market. The only exception is the very long boom for the retail sector,

which ran from 1993 to 2007.

3. Strong returns across all sectors: Across the three boom periods, average annual total

returns range from 16%-21%, with little variation in this return across the individual

categories.

4. Rental growth peaks towards the end of a boom: Strong rental growth was a feature of

Boom 1 and Boom 2, but less so in Boom 3. This can be partly explained by the credit-fuelled

nature of the 2003-2007 period.

5. Strong correlation with the economic cycle: As we will deal with later in the report,

commercial property performance and the economy have historically moved in tandem.

-50

-40

-30

-20

-10

0

10

20

30

40

1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

(Q2)

% Y

oY

Capital Growth Rental Value Growth

Boom1 Boom 2

Boom 3

Boom 4

Goodbody

Page 14 02 Sep. 14

Irish commercial property booms

Time period

No. of

years

Average

annual

Total

Return

Peak

Return Year

Average

annual

rental

growth

Peak rental

growth

Year Yield***

at start

Yield***

at end

Boom 1 Total 1986-1990 5 15.9 35.2 1989 6.6 18.0 1989 8.0 7.4

Retail 1986-1990 5 17.6 33.0 1989 7.2 14.7 1989 8.9 7.4

Office 1986-1990 5 15.2 35.6 1989 6.5 20.2 1989 7.1 7.1

Industrial 1986-1990 5 20.6 42.1 1989 7.4 14.7 1990 11.6 10.1

Boom 2 Total 1993-2001 9 20.7 38.6 1998 8.5 21.5 2000 8.7 5.7

Retail** 1993- 9 19.3 34.4 1998 6.6 15.9 2000 8.7 5.2

Office 1993-2001 9 21.6 43.1 1998 10.0 25.6 2000 8.3 5.9

Industrial 1993-2001 9 20.6 28.9 1998 6.4 13.4 2000 11.1 6.9

Boom 3 Total 2003-2007 5 17.1 27.2 2006 3.2 5.4 2007 6.0 4.0

Retail** 2003-2007 5 21.7 27.7 2005 8.1 10.1 2003 5.0 3.3

Office 2003-2007 5 15.2 27.6 2006 1.4 6.1 2007 6.2 4.4

Industrial 2003-2007 5 13.4 25.4 2006 0.8 2.1 2006 7.1 5.0

Boom 4 Total 2013-

19.7

6.9

6.8

Retail 2013-

12.3

-4.7

6.6

Office 2013-

25.6

14.8

6.9

Industrial 2013-

11.8

1.7

6.9

Source: Goodbody

*boom is defined as a total annual return of greater than 5%

**retail boom actually ran from 1993-2007

***Reversionary yield

International comparisons

Cycles are not a phenomenon exclusive to Ireland. Ireland’s closest neighbour – the UK – has also

experienced a number of boom and bust episodes over recent decades. It is the case, however, that the

amplitude of these cycles is not as large as it has been in Ireland over this time period. For example, the

peak return in the late 1980s was 30%, relative to 35% in Ireland. The UK didn’t experience the same

kind of downturn in the early-2000s. Rental cycles have not been as severe, while yields did not fall as

low as they did in Ireland.

UK commercial property cycles

Source: IPD

UK commercial property yield

Source: IPD

-30

-20

-10

0

10

20

30

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

% Y

oY

Capital growth Rental Value Growth

0

2

4

6

8

10

12

%

Goodbody

02 Sep. 14 Page 15

Stages of a cycle: The market is rarely in equilibrium

From this practical experience, we can divide the market cycles into distinct phases. The following chart

illustrates this (taken from Predicting Long-Term Trends & Market Cycles in Commercial Real Estate,

Glenn R. Mueller), with the market cycle being divided into four distinct quadrants. The key point, in

particular due to development lags, is that the market is never in equilibrium whereby demand equals

supply. Mueller describes the market as having two distinct up-cycles and two down-cycles.

Phase 1 - Recovery: At the initial stages of recovery, there is no new construction and vacancy is

starting to decline.

Phase 2 – Expansion: At the expansion stage, rental values have moved to a sufficient extent to make

it economical to build.

Phase 3 – Hypersupply: After the peak of the cycle (usually coinciding with the peak of the economic

cycle), vacancy starts to increase, but new construction continues

Phase 4 – Recession: As vacancy continues to increase, rents fall and it becomes uneconomical and

unwise to develop new units, but previously started units continue to come on the market, exacerbating

the downturn.

Goodbody

Page 16 02 Sep. 14

Market cycles and the Dublin office market

In addition to the IPD returns data, we can also analyse a number of other relevant variables in relation

to the Dublin office market. In the following table, we have included these variables around the “boom”

periods mentioned in the previous section. One can see that, following the recession, Mueller’s cycles

describe the situation in the Dublin market very well.

Dublin office cycles

Cycle 1 1986 1987 1988 1989 1990 1991 1992

Total return 6.9 15.5 35.6 12.5 -1.6 -3.5 4.7

Capital values -2.1 -1.0 7.2 27.3 6.2 -7.4 -9.9

Rental growth -1.9 0.1 2.7 20.2 11.5 -0.2 -1.3

Completions/stock 1.6 2.5 1.4 1.5 7.7 11.1 1.0

Vacancy rate

5.0 4.0 3.7 5.4 6.4 10.2

Yield 8.2 7.8 7.7 7.3 6.9 6.1 5.6

Cycle 2 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Total return 4.7 14.4 11.9 19.4 26.4 43.1 36.5 31.4 6.8 -2.4

Capital values -3.3 5.6 3.6 10.7 17.9 35.2 30.2 25.8 2.0 -7.4

Rental growth -3.2 1.1 3.1 7.0 12.1 18.7 18.8 25.6 6.6 -0.5

Completions/stock 1.9 2.0 2.3 5.4 6.4 6.7 10.9 8.1 17.5 10.8

Vacancy rate 9.8 9.8 6.4 3.9 3.3 3.3 5.9 5.8 15.9 20.8

Yield 8.2 7.8 7.7 7.3 6.9 6.1 5.6 5.7 5.9 6.2

Cycle 3 2003 2004 2005 2006 2007 2008

Total return 6.2 7.9 23.7 27.6 10.5 -31.1

Capital values 0.2 1.3 16.7 21.7 6.0 -34.4

Rental growth -1.6 -1.4 0.3 3.8 6.1 1.2

Completions/stock 4.5 2.6 3.6 4.2 9.2 10.5

Vacancy rate 18.1 15.2 13.3 11.7 10.3 17.5

Yield 6.1 6.0 5.1 4.4 4.4 6.9

Source: IPD, Lisney, Goodbody

Some important lessons can be learned from these cycles:

1. Completions do not recover until rental growth begins to feed through.

2. Rental growth peaks 1-2 years ahead of the peak in completions. This follows a classic cycle as

the maximum incentive to build is at the peak rental growth level, but development lags of two

years mean that the market is in a different phase once completions come on stream.

3. Rental growth was relatively muted in the 2003-2007 boom due to the large boom in

completions that preceded it. Capital values grew strongly due to a contraction in yields.

Where in the cycle is the Dublin office market?

Having increased by increased by 25% since the Q1 2013 trough and prime office yields falling from a

peak of 7.5% to the current sub-5% level, the market has clearly moved beyond the distressed phase.

The vacancy rate has fallen from over 20% to c.15%, while price and rents have moved up sharply. This

has all occurred over a relatively short period of time. Despite these swift movements, we believe that

the market can still be put in the recovery phase in the chart on page 15. This is supported by our view

that the Irish economic recovery is actually gaining momentum and becoming more broad-based.

The key issue here is supply. Despite strong rental growth, there remains only modest new construction

activity ongoing (2 buildings in Dublin). These will come on stream in late 2015/2016 and are likely to be

supplemented by some refurbished stock. However, the scale of this new supply is likely to remain

small, even in 2016, possibly amounting to c.1% of the office stock. As can be seen in the table above,

this would be low in an historical context. As a result, we expect rental growth to remain strong over the

coming years. While there is little visibility on when new building will come on stream, the incentives to

do so will grow along with stronger rental growth, and we may see new completions peak towards the

end of the decade.

Goodbody

02 Sep. 14 Page 17

The speed of this supply response will more importantly depend on a number of key issues:

(i) Access to domestic sources of finance: Given the nature of the most recent crash, there

may be some reluctance on the part of the banks to fund construction development.

(ii) Capacity: The scale of the crash resulted in a significant reduction in the number of

developers with the scale necessary to build out large office projects.

(iii) NAMA: NAMA is a significant player in the Dublin office market and their actions, in terms

of access to finance and sales decisions, will play a major role.

(iv) Planning: Planning processes are blamed for the slow development process in Ireland;

recent moves to designate Strategic Development Zones (SDZ) aim to address these in

specific areas of the city.

Supply peaks follow rental growth

Source: Lisney, IPD, Goodbody

Recent office market dynamics

Take-up and vacancy rates

Gross take-up in the Dublin office market in 2013 amounted to 171,000 sqm, the highest level since

2008. These strong trends have continued into 2014, with c.100,000 sqm of take up in the first six

months of this year. This is up 23% yoy, with agents reporting a strong pipeline of interest for the

second half of the year. Estimates for the full-year outturn range between 160,000-200,000 sqm.

The city centre continues to account for the bulk of the take-up (63% in H1, according to Savills). Within

this, tenants continue to favour prime Grade A buildings in the traditional CBD of the city.

-2

0

2

4

6

8

10

12

14

16

18

20-30

-20

-10

0

10

20

30

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

(Q2)

Office rental growth (LHS) Completions/stock (RHS, Inverted)

Peak rental

growth=1989

Peak rental

growth=2000

Peak rental

growth=2007

Supply peak=1991

Supply peak=2001 Supply peak=2008

Goodbody

Page 18 02 Sep. 14

Take-up by region – 2003-2014

Source: Lisney

Take-up by region – H1 2014

Source: Lisney

From a sectoral perspective, the IT and financial sectors have dominated demand over recent years.

Take-up in the IT sector accounted for 47% of the total in H1 2014 and has been a key element of the

take-up since 2010 due to the influx of companies such as Google, Facebook and LinkedIn and their own

expansion. In this regard, Sherry Fitzgerald notes that 57% of the take-up in the CBD area was in the IT

sector. Financial and business services have also contributed strongly to demand over recent years.

The growth in the demand for office space must be seen in the context of the structural shift that is

ongoing in the Irish economy thanks to the influx of FDI. This is particularly relevant to office space

demand in the capital. Interestingly, a recent study carried out by Dr. John McCartney of Savills found

that although total employment fell between 2006-2011 (the two Census periods), office based

employment grew over the period. In Dublin, all of the net increase in jobs over 2006-2011 was

accounted for by office-based employment. As a result, office based employment in Dublin rose to 56%

of the total, relative to 39% for the country as a whole.

Take-up by sector (% of total)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

H1

Professional

Services 10% 35% 27% 11% 11% 21% 17% 13% 6% 4% 12% 6%

Financial 28% 9% 26% 33% 45% 24% 17% 17% 18% 19% 27% 10%

State 18% 4% 5% 16% 10% 11% 8% 6% 6% 17% 6% 11%

IT 12% 19% 21% 11% 14% 20% 26% 32% 39% 26% 27% 47%

Pharmaceutical

/ Health/life

sciences

6% 3% 4% 4% 9% 5% 5% 9% 5% 8% 9% 8%

Media

2% 0% 4% 2% 0%

Education

11% 3% 0% 1%

Other 26% 30% 18% 25% 10% 19% 27% 21% 16% 19% 17% 16%

Total ('000

sqm)

149

189

206

234

299

181

84

124

164

142

171

100

Source: Savills

On a headline basis, vacancy rates in the Dublin office market look high. Rates vary across the different

property agents due to definitional issues, with Savills putting the current rate at c.13%, while Lisney

believe it is closer to 17%. All agents agree, however, that the vacancy rate has fallen significantly since

2011 and will continue to fall over the next two years due to the absence of additional supply. Savills

suggest that the vacancy rate for Dublin overall has fallen by more than ten percentage points since

early 2011, Lisney report a seven percentage point drop, while CBRE suggest that the rate has fallen by

a similar extent.

0

50

100

150

200

250

300

350

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 H1

'000 s

qm

City Centre North Suburbs South Suburbs West Suburbs H2 2014 Expected

64%8%

15%

13%

City Centre

North Suburbs

South Suburbs

West Suburbs

Goodbody

02 Sep. 14 Page 19

What will the vacancy rate fall to?

The most relevant demand variable for calculating the vacancy rate, rather than gross take-up, is net

absorption. This tracks the change in occupied space, thus taking the churn in the market into account.

Using data provided by Lisney, we attempt to estimate the change in the vacancy rate for Dublin overall

to the end of 2016.

Under our baseline scenario, we assume that gross take-up amounts to 185,000sqm in 2014 and

150,000 sqm in both 2015 and 2016. We assume churn in the market to be in line with recent trends.

Under these assumptions, the vacancy rate will fall to c.10% by the end of 2016, in line with the low

achieved in the most recent cycle in 2007.

Under a more aggressive assumption of gross take-up of 200,000sqm, the vacancy rate could fall to

c.8%, while a less aggressive take-up assumption of 100,000sqm in 2015/2016 would mean a vacancy

rate of 13%.

Gross office take-up versus net absorption

Source: Lisney, Goodbody

Scenarios for the vacancy rate to 2016

Source: Goodbody

Regional and quality differences in vacant stock

Given the high headline vacancy rates, some are surprised by the pace of rental growth that has been

seen to date in the office market. This is why a more granular analysis of the data is required when

looking at the Dublin market, with significant variations across both quality and location. For example,

the vacancy rate in the Dublin 1/3/7 area currently stands at 23%, while in Dublin 2/4, the vacancy rate

stands at 9%.

Recent take-up trends suggest that tenants have an overwhelming preference for Grade A space,

particularly in the Central Business District. In this regard, extremely low vacancy in this space (3% for

Grade A buildings in the Dublin 2/4 area for instance), explains the sharp increase in rents recently.

Availability of Grade A space in the IFSC is also at historically low levels. In contrast, the vacancy rate

for Grade C buildings in the South West suburbs currently stands at 32% (Savills). This is reflective of

the preference for Grade A space, and resulted in the proportion of vacant Grade A space falling from

22% in 2013 to 17% currently. Grade B makes up 44% of vacant space while Grade C buildings account

for 49%. Grade C buildings are considered to be practically obsolete, with Grade A & B buildings

accounting for the vast majority of gross take-up. In gross terms, we estimate that Grade A and Grade B

vacancy amounts to c.300,000sqm. This represents less than two years of supply at current take-up

trends, not even accounting for the average sizes of these properties.

-50

0

50

100

150

200

250

300

350

sqm

('0

00)

Take-up Net absorption

0%

5%

10%

15%

20%

25%

Vacancy r

ate 13%

10.5%

8%

Gross take-up assumptions:

High: 200K per annum

Base: 150K per annum

Low: 100K per annum

Goodbody

Page 20 02 Sep. 14

Dublin office vacancy varies by area of city…

Source: CBRE

…and by quality of space

Source: CBRE

Prime rents to go back to peak levels

Our earlier analysis showed the importance of supply in the evolution of rents. Given the highly volatile

and cyclical nature of office construction, it is no surprise, therefore, that office rents in the Dublin

market exhibit a similar trend. Having peaked at €670 per square metre in 2007, prime office rents fell

to a trough of €320 per square metre in early 2012. Since then, prime office rents have spiked, growing

by 16% in 2013 (to €355 per square metre) and by a further 16% in H1 2014 alone. It is now expected

that rents will hit €475 per square metre by the end of the year, representing growth in prime rents of

c.33%. We are anticipating prime rents to grow to the previous peak of €670 by the end of the forecast

period in 2018. The following chart tracks the change in real yields (using CPI as the deflator) over the

period since 1970. The expected movement over the coming years would be consistent with the cyclical

nature of rental growth.

Real office rents* (1970-2018f)

Source: Lisney, Goodbody

Are rents rising too quickly?

Dublin is once again starting to surpass its European peers in term of office rental costs. Over the twelve

months to Q1 2014, Dublin experienced the fourth largest annual increase in rental levels in the world

(CBRE). With other major European cities, such as Paris and the German cities, coming towards their

cyclical highs and London being further through its recovery phase, it is inevitable that rental levels in

Dublin will gain on or even surpass other major European cities in the coming quarters. On a global scale

Dublin was ranked the 48th most expensive office location as of Q1 this year in CBRE’s 50 most

expensive cities in the world based on prime office occupancy costs. In a European perspective, Dublin

now ranks tenth, behind cities such as Stockholm, Oslo and Frankfurt.

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

25%

South

Suburbs

2/4 IFSC City

Centre

Total 6/8 Suburbs 1/3/7

Vacancy r

ate

0%

5%

10%

15%

20%

25%

€0.00 €1.00 €2.00 €3.00 €4.00 €5.00 €6.00

Vacancy r

ate

Overall Grade A

Dublin 1/3/7 Dublin 2/4 Dublin 6/8 IFSC City Centre

Overall

0

50

100

150

200

250

300

Dec-

70

Dec-

76

Dec-

82

Dec-

88

Dec-

94

Dec-

00

Dec-

06

Dec-

12

Dec-

15 (f)

Dec-

18 (f)

Index (

1970=

100)

Goodbody

02 Sep. 14 Page 21

This is obviously damaging from a competitiveness perspective, but it must be noted that property costs

represent a very small proportion of the total costs of operating for the services sector. The 2014 “Costs

of Doing Business in Ireland” report from the National Competitiveness Council states that leasing costs

represent just c.10% of location sensitive costs, while in the digital sector, leasing costs are less than

5% of the total. Labour costs are, by far, the most important cost consideration for these types of firms.

Prime office rents compared (Q2 2014)

Rank City

Prime Rent

(€/SqM/An

num)

Prime Yield

(%) Rank City

Prime Rent

(€/SqM/An

num)

Prime Yield

(%)

1 London-West End 1445 3.75 21 Vienna 306 4.65

2 Paris 800 4.00 22 Warsaw 306 6.00

3 London-City 786 4.50 23 Madrid 297 5.50

4 Geneva 762 4.00 24 Gothenburg 295 4.75

5 Zurich 679 3.20 25 Hamburg 288 4.55

6 Stockholm 492 4.50 26 Brussels 285 6.00

7 Milan 480 5.75 27 Marseille 270 6.00

8 Oslo 476 5.25 28 Berlin 270 4.65

9 Frankfurt 456 4.70 29 Athens 264 8.50

10 Dublin 431 5.00 30 Kyiv 261 14.50

11 Helsinki 408 4.60 31 Lyon 260 5.50

12 Munich 396 4.45 32 Budapest 240 7.50

13 Manchester 391 5.75 33 Prague 234 6.00

14 Rome 380 6.25 34 Rotterdam 225 5.90

15 Birmingham 371 5.75 35 Lisbon 222 7.00

16 Edinburgh 371 5.75 36 Copenhagen 221 5.00

17 Bristol 358 5.75 37 Lille 220 5.40

18 Glasgow 352 6.00 38 Bucharest 216 8.00

19 Amsterdam 345 5.45 39 Barcelona 213 5.50

20 Dusseldorf 330 4.70 40 The Hague 210 5.90

Source: CBRE

While we are not concerned about the effect of the spike in rents on the flow of FDI coming into the

country (as long as it is not accompanied by an increase in other costs at the same time), the spike in

rents may force some potential tenants to search for alternative options outside of the traditional CBD

area. In this regard, it is worth noting that significant differences exist in office rents across the capital.

Dublin headline office rents – Q2 2014

Source: CBRE

0

50

100

150

200

250

300

350

400

450

500

City Centre South Suburbs North Suburbs West Suburbs

€ p

er

square

metr

e

Goodbody

Page 22 02 Sep. 14

Retail sector – early signs of recovery emerging

Given the weakness of Irish consumer spending over recent years, it is no surprise that the retail sector

has struggled. This is reflected in the fact that rents have continued to fall on an annual basis up to Q2

2014 (-3.5%), the worst performer in the commercial property space. Retail rents remain 50% below

peak levels.

Retail has stabilized due to lower yields…

Source: IPD, Goodbody

…while rental growth continues to be weak

Source:IPD, Goodbody

Despite this, there has been a tightening of yields seen over the past twelve months, with CBRE

reporting a fall in Prime High Street rents from 5.75% to 4.75%. This is due to the expectation of a

return to rental growth in the sector over the coming years. While we still have concerns about the

consumer spending environment over the coming years due to the still large overhang of household

debt, more encouraging signs have been seen of late, with employment and household disposable

incomes growing, increased expectations of income tax cuts and improved consumer confidence. A

comparison of rental levels across Europe also reveals that Ireland is now in the middle of the pack,

which is inconsistent with the relative level of prosperity in the country and the brightening prospects

over the next few years.

Prime High Street rents

Source: Cushman & Wakefield

Investment in the sector is now picking up from very low levels, with the office sector dominating over

recent years. In Q1 2014, €311m had been invested in the Irish retail market of which €250m was on a

single shopping centre purchase.

0

100

200

300

400

500

600

700

Index (

Q4 1

994=

100)

Retail rents Capital values

-30%

-20%

-10%

0%

10%

20%

30%

Q1-02 Q3-03 Q1-05 Q3-06 Q1-08 Q3-09 Q1-11 Q3-12 Q1-14yoy

Retail Office

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Sofia

Bra

tisla

va

Buchare

st

Wars

aw

Lis

bon

Budapest

Luxem

bourg

…

Sto

ckholm

Mancheste

r

Bir

min

gham

Edin

burg

h

Bru

ssels

Hels

inki

Ath

ens

Pra

gue

Gla

sgow

Copenhagen

Dublin

Oslo

Madrid

Am

ste

rdam

Barc

elo

na

Geneva

Dusseld

orf

Berlin

Vie

nna

Ham

burg

Fra

nkfu

rt

Munic

h

Rom

e

Zurich

Milan

London

Pari

s

€ p

er

square

metr

e

Goodbody

02 Sep. 14 Page 23

The legal environment in the retail sector has been a concern over recent years but has now been

clarified somewhat. Upward only rent reviews have been banned on new leases, but there was some

uncertainty about whether the government would try to implement this ban to current leases. The

government has been given legal advice that it could not implement such a provision. While there is still

some uncertainty about specific leases (the Bewley’s case for instance), the more prominent concerns

for investors in the sector have now passed.

Industrial – rents climbing from low levels

The industrial and logistics market in Ireland has been the laggard due to various issues. However, like

the rest of Irish property, the industrial market is also seeing a turnaround. For the first time since the

recession, industrial property rents have risen. This has been underpinned by the strong growth in

logistics rents, which have climbed to €70 m2/year (+17% yoy). CBRE projects further price appreciation

in the industrial market as investment in the sub-sector grows.

There also exist further tailwinds within the logistics market. As the tech sector expands in Ireland,

logistics and server warehousing will increasingly be needed. Additionally, online retailing in both Ireland

and the rest of Europe has expanded rapidly, meaning that logistics facilities will be needed in the

future.

Logistics rents compared – Q1 2014

Source: Cushman & Wakefield

0

20

40

60

80

100

120

140

160

180

Buchare

st

Budapest

Sofia

Bra

tisla

va

Pra

gue

Bru

ssels

Ath

ens

Lis

bon

Pari

s

Milan

Rom

e

Vie

nna

Barc

elo

na

Madrid

Wars

aw

Copenhagen

Ham

burg

Dusseld

orf

Berlin

Dublin

Mancheste

r

Bir

min

gham

Gla

sgow

Fra

nkfu

rt

Munic

h

Luxem

bour…

Am

ste

rdam

Hels

inki

Moscow

Edin

burg

h

Sto

ckholm

Zurich

Oslo

Geneva

London

€ p

er

square

metr

e

Goodbody

Page 24 02 Sep. 14

Residential property

Following a peak to trough fall in house prices of 51% between September 2007 and March 2013, Irish

house prices started to stabilise in the third quarter of 2012 and registered their first annual increase in

June 2013. Since the trough house prices have risen by 16%, outpacing expectations. The most recent

figures for July show that prices are rising at an annual rate of 13%. The improvement has been driven

by Dublin where prices have increased by a third since their trough in August 2012 and are increasing by

23% yoy. However, the recovery has become more broad based with prices outside Dublin also rising

since the start of 2014, and currently increasing at an annual rate of 5%, the fastest pace since Q4

2007. Faster than expected growth in house prices has prompted speculation that another bubble is

building. However, there are a number of reasons we think fears of a bubble are premature and that

indeed the residential property market has further to go.

House prices rising across the country…

Source: CSO

…but still in early stage of recovery

Source: CSO, Goodbody *sample of 10 recoveries after price crashes

The recovery is in its early stages and tracking previous international cycles

While house prices have reversed some of the peak to trough decline experienced during the 5 ½ year

housing market collapse, they have increased just 17% from the trough and remain 42% lower than

peak levels. In real terms this means that 16 months after the trough, house prices have recovered 15%

of their peak to trough loss (a rate of c.0.9% per month). This compares to the average 62% price drop

recovered after 5 years (averaging c.1% per month) seen across 10 previous international house price

crashes we looked at since 1970. Our forecasts are more conservative and we estimate that by the end

of 2016, almost 4 years after the trough, house prices will only have recovered 31% of their real price

drop (40% of their nominal drop).

Despite the earlier, faster recovery, the picture in Dublin is similar where 22% of the price fall has been

recouped almost 23 months after the trough, again a recovery rate of c.1% per month. In real terms,

we estimate that 42% of the peak to trough drop will be recovered in the capital by the end of 2016,

which is almost 4 ½ years after the trough.

In addition, to the rate at which the peak to trough losses are being recouped, the average annual

increase in real house prices since the trough of 5% is in line with the average of 6% pa seen in the

other property cycles. On this basis the Irish house price recovery is performing in line with the average

of previous international cycles.

-30%

-20%

-10%

0%

10%

20%

30%

Jun

06

Dec

06

Jun

07

Dec

07

Jun

08

Dec

08

Jun

09

Dec

09

Jun

10

Dec

10

Jun

11

Dec

11

Jun

12

Dec

12

Jun

13

Dec

13

Jun

14

% Y

oY

Non Dublin Property Dublin property

0%

10%

20%

30%

40%

50%

60%

70%

National Dublin "International

recoveries"* - 5 years

after trough

% o

f price d

rop r

ecovere

d

Current

End-2016 (4 years after trough)

Goodbody

02 Sep. 14 Page 25

Ireland’s recent housing crash & recovery in context

Source: CSO, BIS, Goodbody

Supply shortages will keep driving prices

Theses shortages are manifesting themselves in two interlinked ways: (i) insufficient new supply, and;

(ii) shortages of stock for sale.

(i) House building is failing to keep pace with requirements

Using the latest CSO data we updated our housing demand calculations based on the assumptions

outlined in the table below and looked at forecasts based on an average of the high and low migration

assumptions.

Population assumptions

Low Migration High Migration

Fertility Total fertility rate to remain at

2010 level of 2.1

Total fertility rate to remain at

2010 level of 2.1

Mortality

Assumed to decrease, which

will result in gains in life

expectancy- the long term

gains in life expectancy is

assumed at 1.5%

Assumed to decrease, which

will result in gains in life

expectancy- the long term

gains in life expectancy is

assumed at 1.5%

Migration 2011-2016: -21,000 2011-2016: -19,100

2016-2021:+4,700 2016-2021: +18,200

2021-2026: +10,000 2021-2026: +30,000

Source: CSO

From this we estimate that between 2011 and 2016, an additional 8,000 new homes per annum are

needed to meet housing requirements. All of these are required in the Greater Dublin Area (GDA) which

encompasses Dublin and the neighbouring counties of Wicklow, Meath and Kildare. Excess stock built

during the boom years means that the requirement for new houses outside of this area does not become

a factor until the following five year period of 2016-2021. During that five year period a further 25,000

new homes per annum will be required, and while 14,000 or just over half of these are needed in the

GDA, c.11,000 are required in the rest of the country. In the medium term, we estimate c30,000 units

are required nationally pa.

40

50

60

70

80

90

100

110

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Index

Average Property Cycles for UK, Netherlands, Switzerland, Belgium, Finland, Sweden,

Denmark, Norway, New Zealand, SpainIreland's Current Cycle

Goodbody

Page 26 02 Sep. 14

Housing demand calculations

Border Dublin Mid-East Midlands Mid-West South-

East

South-

West West State

Total Stock 249 532 206 121 171 224 307 212 2,022

Vacancy Rate 2014 15.6% 6.8% 5.1% 11.2% 11.9% 10.0% 11.2% 15.9% 10.4%

"Excess" vacancy

rate 8.6% -0.2% -1.9% 4.2% 4.9% 3.0% 4.2% 8.9% 3.4%

Obsolete units

(0.3% of stock per

annum)

1 2 1 0 1 1 1 1 6

Housing supply needs

Low Migration

2011-2016 - 4 3 - - - - - 8

2016-2021 - 8 4 2 1 3 4 - 22

2021-2026 2 8 4 2 1 3 4 2 27

High Migration

2011-2016 - 5 3 - - - - - 8

2016-2021 - 10 5 2 1 3 4 0 27

2021-2026 3 11 6 3 2 4 5 2 36

Source: Goodbody

The current pace of house building is insufficient to meet the projected demand. Between 2011 and

2013 completions averaged 9,100 per annum, with just 2,400 pa of these in the GDA, short of the 8,000

units pa we estimate are required in the region during this period. This has exacerbated the shortage of

housing in the capital and translated into the squeeze in prices and rents seen over the past year.

The number of completions in 2013 was equivalent to 1.8 per 1000 of the population, among the lowest

in Western Europe (only Spain and Denmark were lower) were lower, despite the superior demographic

profile in Ireland. On a regional basis within Ireland, the number of completions ranged between 1.3 in

Tipperary and 3.5 in Carlow. The key point here is that completions are not necessarily occurring in the

areas of the country that most need them, namely the Greater Dublin Area.

Completions per 1000 in the EU…

Source: Euroconstruct

…and in Ireland

Source: DoELG, CSO

2014 has seen a pick-up in completions and in the twelve months to the end of May, completions

nationally amounted to 9,200 (+13% yoy). Of these 3,000 were in the GDA, which represents a 36%

yoy increase. However, these fall well short of our medium-term requirement estimates of c.14,000 and

30,000 units pa respectively for the GDA and nationally.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Com

ple

tions p

er

000s

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Com

ple

tions p

er

Thousand

Goodbody

02 Sep. 14 Page 27

Completions are growing strongly…

Source: Department of the Environment

…but remain at low levels


Commencements growing fast, but from a low base.

Housing commencements, as a leading indicator of completions, are now also pointing to rapid growth

from a very low base. Official data is only available to February, but it shows there was a surge of

activity ahead of the introduction of new building standards at the beginning of March 2014. In the

twelve months to end-February 2014, commencements grew 120% compared to a year earlier. These

growth rates will ease over the coming months, but in absolute terms there were 5,200 commencements

nationally in the opening two months of 2014, which is already 11% ahead of the 4,200 seen over the

whole of 2013. The GDA has seen 2,100 commencements in the opening two months of 2014, 43%

higher than that seen in all of 2013. Notwithstanding the distortions being created by the changes to the

building code, there is clearly momentum in the house building sector. However, it is not yet sufficient to

meet projected demand and, given the time lag between commencements and completions, indicates

that supply shortages will remain a feature.

Commencements are showing momentum…


…but fall short of requirements in Dublin


Highlighting the tight supply conditions is the pace at which the excess housing build up during the boom

is being absorbed. According to the National Housing Development Survey, the total number of houses

that are “complete and vacant” or “near complete” in the State fell by over 50% between 2010 and 2013

to 15,800. Here the regional trends are also highlighted, with the fall driven by Dublin (-71%) and the

Mid- East (-53%) where the ratio of unfinished and vacant housing relative to the number of households

has fallen to just 0.5% (from 1.9% in 2010) and 0.6% (from 1.3% in 2010) respectively. Overall, the

ratio in the State has fallen to 0.9% from 1.9%. The Border remains the region with the highest

proportion of vacant and unfinished housing at 1.7%.

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Dec

08

May

09

Oct

09

Mar

10

Aug

10

Jan

11

Jun

11

Nov

11

Apr

12

Sep

12

Feb

13

Jul

13

Dec

13

May

14

Rollin

g 1

2 m

onth

yoy %

change

Greater Dublin Rest of Country

0

10

20

30

40

50

60

70

80

90

2007 2008 2009 2010 2011 2012 2013

000s

Dublin All other areas

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

000s

All other areas Greater Dublin

0

5

10

15

20

25

30

Dec

07

Jun

08

Dec

08

Jun

09

Dec

09

Jun

10

Dec

10

Jun

11

Dec

11

Jun

12

Dec

12

Jun

13

Dec

13

Jun

14

Dec

14

Rollin

g 1

2 m

onth

tota

ls in 0

00s

Completions Commencements 12 months ahead Required

Goodbody

Page 28 02 Sep. 14

Houses – Complete & Vacant and Near Completion

Border Dublin Mid-East Midland Mid-West South-

East

South-

West West State

2010 Near

Complete 1,792 2,315 1,077 626 179 1,305 1,486 1,196 9,976

2010 Complete and

Vacant 3,540 6,816 1,668 2,015 1,459 1,966 3,775 2,011 23,250

Total 2010 5,332 9,131 2,745 2,641 1,638 3,271 5,261 3,207 33,226

2013 Near

Complete 1,504 1,021 700 540 499 813 1,103 1,000 7,180

2013 Complete and

Vacant 1,849 1,650 589 994 541 826 1,339 906 8,694

Total 2013 3,353 2,671 1,289 1,534 1,040 1,639 2,442 1,906 15,874

% Change -37% -71% -53% -42% -37% -50% -54% -41% -52%

% of households 1.7% 0.5% 0.6% 1.4% 0.7% 0.9% 1.0% 1.1% 0.9%

Source: Department of the Environment Community and Local Government

(ii) Limited stock for sale and for rent also supporting prices

In addition and partly as a function of the shortage of housing, the stock available for either sale or rent

is at or close to record lows and falling. According to daft.ie, there were 33,000 properties listed for sale

nationally in June. This is 20% lower on an annual basis and almost half of that seen at the peak in Q4

2008. It is also only 1.7% of total housing stock which compares unfavourably to the average of 2.8%

seen since 2007. Of the properties listed for sale only 9% are in Dublin, with Munster accounting for the

most at 32%. Dublin stock for sale levels have been below 3,000 since November 2013, which means

that only 0.5% of the existing housing stock is on the market (average since 2007 is 1.1%).

Housing stock for sale remains low

Source: Daft.ie

Rental stock is also close to record lows

Source: Daft.ie

Properties available for rent also remain at low levels. According to daft.ie there were 6,800 properties

available to rent in August, 40% lower than a year ago and 75% below the 2009 peak. In Dublin, the

stock of rental properties has, in the main, been falling at double digit rates since February 2010 and

stood at 2,000 in June, just 0.4% of the total Dublin housing stock. This is 70% below peak levels and

further highlights the squeeze on housing supply in the capital.

Rental are showing double digit increases

Source: Daft.ie, Goodbody

Rent indices have been recovering since 2012

Source: Daft.ie, Goodbody

0

50

100

150

200

250

300

350

400

Jan

07

Jun

07

Nov

07

Apr

08

Sep

08

Feb

09

Jul

09

Dec

09

May

10

Oct

10

Mar

11

Aug

11

Jan

12

Jun

12

Nov

12

Apr

13

Sep

13

Feb

14Index (

Jan 2

007 =

100)

National Dublin Munster Conn-Ulst Leinster

0

100

200

300

400

500

600

700

800

900

Jan

07

Jun

07

Nov

07

Apr

08

Sep

08

Feb

09

Jul

09

Dec

09

May

10

Oct

10

Mar

11

Aug

11

Jan

12

Jun

12

Nov

12

Apr

13

Sep

13

Feb

14

Index (

Jan 2

007=

100)

National Dublin Munster Connacht-Ulster Leinster

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

Jan

08

Jun

08

Nov

08

Apr

09

Sep

09

Feb

10

Jul

10

Dec

10

May

11

Oct

11

Mar

12

Aug

12

Jan

13

Jun

13

Nov

13

Apr

14

yoy %

change

National Dublin

70

75

80

85

90

95

100

105

110

Jan

07

Jun

07

Nov

07

Apr

08

Sep

08

Feb

09

Jul

09

Dec

09

May

10

Oct

10

Mar

11

Aug

11

Jan

12

Jun

12

Nov

12

Apr

13

Sep

13

Feb

14Index (

Jan 2

007 =

100)

National Dublin

Goodbody

02 Sep. 14 Page 29

Are residential prices cheap or expensive?

We update two long-term valuation metrics that we looked at in our property report Foundations of

recovery in September 2013 and look at an additional one, the EBS DKM Affordability Index

The first metric is house price to incomes. Based on data going back to 1970, we estimate that the long

term average price to income ratio is 10.5 times (10 times during the 1970-2002 period prior to the

boom). However, it ranges between 8 and 15.5 times with the upper end experienced during the height

of the bubble in 2006. In Q1 2014 this ratio stood at 9.1, 13% lower than the long term average and

towards the lower end of the range. That said, it does represent an increase on the 8.5 times seen in

2012 and 2013 and indicates that property has become more expensive relative to incomes over that

timeframe. With house prices increases outpacing disposable income growth, we expect that the ratio

will be back to the average of 10.5 by the end of 2016.

Price/income ratio approaching average

Source: Goodbody

The second metric we update here is relative yields. Due to supply issues, both house prices and

residential rents have been rising in tandem leading to stability in rental yields. In Q2 2014, residential

yields nationally were 5.7%. This is in line with the average seen since Q2 2012 and considerably higher

than the bubble years of 2006-2008 when yields averaged 3.7%. It is also higher the 20 year average of

5.4% but below the long term (since 1975) average of 8%. It compares favourably with government

bond yields which have been falling since 2011 and averaged 2.3% in Q2. While we expect yields to fall

back modestly by the end of the year, government bond yields are also falling and we expect the

positive carry in rental yields to remain close to 3%, the best level since the 1970s.

7

8

9

10

11

12

13

14

15

16

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014f

2016f

Price/d

isposable

incom

e p

er

capita

Average (1970-2014)

Average (1970 -2002)

Goodbody

Page 30 02 Sep. 14

Residential yields remain attractive

Source: CSO, FactSet, ptsb, DoELG, Goodbody

It is worth noting that yields vary considerably across the country. According to daft.ie, in Q2 2014

rental yields ranged between 3.7% for a 5 bed in South Dublin City to 8.6% for a 2 bed in Limerick or

Cork cities. The recovery in rental yields diverges across regions and property sizes.

Snapshot of residential yields

2-bed 5-bed Average

2007 Q2 2014 2007 Q2 2014 2007 Q2 2014

Dublin City Centre 4.1 7.8 * * 3.5 8

North Dublin City 3.6 6.9 1.9 5.0 3.3 6.1

South Dublin City 3.8 6.3 4.2 4.5 3.9 5.9

North Dublin County 4.0 6.9 2.1 4.5 3.7 5.9

South Dublin County 3.4 6.2 4.9 3.7 3.3 5.4

West Dublin County 4.2 7.7 2.8 4.2 3.9 6.6

Dublin Commuter Counties 3.6 7.7 2.9 4.2 3.2 5.7

West Leinster 3.3 7.9 2.5 4.1 2.9 5.9

South East Leinster 3.5 7.4 2.9 4.1 3.0 5.5

Munster 3.8 7.1 2.8 4.0 3.1 5.2

Cork City 3.6 8.6 2.7 5.0 3.5 6.3

Limerick City 3.9 8.6 3.1 6.3 3.7 7.2

Waterford City 3.7 8.3 3.3 5.9 3.4 7.4

Connacht/Ulster 3.4 6.8 2.5 3.9 2.9 5.7

Galway City 3.1 8.0 2.4 4.1 3.1 6.8

National 3.6 7.2 2.6 4.1 3.1 5.7

Source:Daft.ie

The third metric we look at is EBS DKM affordability Index. This index measures the proportion of net

income that a first time buyer (FTB) working couple makes in mortgage repayments. Salary calculations

are based on average earnings, with Dublin getting a 10% premium.

On this measure the percentage of net income being used to fund mortgages peaked in 2006 at 26%

nationally and 33% in Dublin. In line with the trajectory of house prices, the ratio troughed in 2011 at

12% nationally, and 14% in Dublin, less than half the level seen at the peak. Since the trough, this ratio

has been increasing and the most recent EBS/DKM figure for February 2014 shows that FTB couples

nationally spend 19% of their net income on mortgage payments while for those in Dublin it has risen to

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014fResidential yield Irish 10-year yield

Spread over 10-year gov. yield Average spread

Goodbody

02 Sep. 14 Page 31

23%. In line with the price to income ratio, this indicates that affordability is deteriorating. However, it

remains 30% below the levels seen at the peak both nationally and in Dublin.

Proportion of net income used to fund mortgages is rising but remains 30% below the peak

Source: DKM

The market is not yet functioning properly

Despite some recent increases, property transactions and mortgage lending remain subdued by both

historical standards and in terms of the size of the market.

Since January the growth in property transactions has been accelerating and on a rolling 12 month basis

they rose by 30% yoy in July. Dublin continues to dominate activity accounting for 35% of transactions

versus and only 26% of the housing stock. With transaction data only going back to 2010, there is no

long term comparative. However, the average number of transactions per month in 2014 at 2,600 is

50% higher than the 1,700 seen in 2010. While this has seen total transactions as a proportion of

housing stock increase to 1.8% from 1% in 2010 (Dublin 2.3%) this compares unfavourably with the

current UK rate of 4.3%.

Transactions are increasing…

Source: NPPR

…but remain comparatively low

Source: NPPR, CSO, HM Rev & Customs, DCLG

Gross mortgage lending has also picked up, with the volume of drawdowns up by 49% yoy in Q2 and

data since then points to continued momentum with mortgage approvals growing at 53% yoy in July.

However, like the transactions data, mortgage lending is coming from a low base and in absolute terms

mortgage lending in the 4 quarters to Q2 totalled €2.9bn, 93% below the peak level of €39.9bn.

0

5

10

15

20

25

30

35

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

% o

f net

incom

e t

o fund m

ort

gages

National Dublin

0

4

8

12

16

20

24

28

32

36

Dec

10

Mar

11

Jun

11

Sep

11

Dec

11

Mar

12

Jun

12

Sep

12

Dec

12

Mar

13

Jun

13

Sep

13

Dec

13

Mar

14

Jun

14

000s T

ransactions (

rollin

g 1

2M

) +30% YoY in July

0%

1%

2%

3%

4%

5%

Dec10

Feb11

Apr11

Jun11

Aug11

Oct11

Dec11

Feb12

Apr12

Jun12

Aug12

Oct12

Dec12

Feb13

Apr13

Jun13

Aug13

Oct13

Dec13

Feb14

Apr14

Jun14

Tra

nsa

ctio

ns a

s %

hou

sin

g s

tock

Dublin Total UK

Goodbody

Page 32 02 Sep. 14

This lack of credit is highlighted by the fact that 50% of the market (in both cash and volume terms) is

still conducted on a non-mortgage basis. We anticipate that mortgage lending will reach €3.8bn in 2014,

half of the level considered “normal” level in 2014.

Gross mortgage lending is trending higher

Source: IBF

Ratio of mortgages to transactions

Source: NPPR & IBF

Key housing metrics & forecasts

2011 2012 2013 2014f 2015f 2016f

House completions 10,480 8,488 8,301 10,600 12,993 15,253

Average house price (€,

end-year) 175,769 167,860 178,575 199,882 215,095 229,453

Price inflation (% YoY, end-

year) -17% -4% 6% 12% 8% 7%

- Dublin (% YoY, end-year) -19% -2% 16% 18% 11% 7%

- Non-Dublin (% YoY, end-

year) -15% -6% 0% 7% 6% 6%

Gross mortgage lending

(€m) 2,463 2,636 2,495 3,753 4,612 5,800

Growth in gross lending -48% 7% -5% 50% 23% 26%

Net mortgage lending

growth (end -year) -3.9% -2.9% -3.3% -2.0% -1.2% -0.2%

Gross rental yield (end-

year) 5.1% 5.5% 5.6% 5.4% 5.2% 5.2%

Source: CSO, DoELG, IBF, Goodbody

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

Q1

2010

Q3

2010

Q1

2011

Q3

2011

Q1

2012

Q3

2012

Q1

2013

Q3

2013

Q1

2014

% Y

oY

Annual change Two-year change

67%64%

59%56%

52% 53%55%

61%

37%

46%51%

45% 46%49%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Q12011

Q22011

Q32011

Q42011

Q12012

Q22012

Q32012

Q42012

Q12013

Q22013

Q32013

Q42013

Q12014

Q22014

% of mortgages to transactions (volume)

Goodbody

02 Sep. 14 Page 33

The Construction Sector – mean reversion expected

At its peak in 2006, construction accounted for 25% of Irish GNP, with the residential sector accounting

for 60% of this output. This was significantly ahead of the long-term average of 13% of GNP,

highlighting the highly unbalanced nature of the economy at that time. Following its collapse,

construction fell to a trough of 6.6% of GNP in 2012. Output in the sector grew strongly in 2013

(+17%), but as the following chart shows, it remains well below long term averages.

Construction output (as a % of GNP)


We expect a mean reversion over the coming years to bring output in the sector back to the European

long-term average of 11% of GNP by the end of the decade. Under this scenario, the value of Irish

construction output would grow at an average pace of 11% per annum. A less optimistic scenario,

growing the sector to 10% of GNP by 2020, would still bring about growth of 10% per annum, while

growing the sector to 13% of GNP would imply 14% annual compound growth. Our forecasts to 2016

assume growth in construction output of 15% per annum.

Scenarios for construction output to 2020


0%

5%

10%

15%

20%

25%

30%

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Residential Roads Other construction

Long-term average Average (1970-2000)

0%

5%

10%

15%

20%

25%

30%

1997 2000 2003 2006 2009 2012 2015 2018

% o

f G

NP

Base case Conservative Optimistic EU historical average

Compound growth: Base: 11% pa Conservative: 10% pa Optimistic: 14% pa

Goodbody

Page 34 02 Sep. 14

The most recent data suggest that this journey is well in train, with both the construction PMI and real

activity indicators pointing to strong growth in the sector in 2014. Output in the sector has grown on an

annual basis for six consecutive quarters, a streak not seen since 2008. Despite this, output remains

50% below peak levels.

Construction output growth

Source: CSO

Construction PMIs strong across the board

Source: Markit

What is holding back construction activity?

While impressive growth rates are being seen, these are from an exceptionally low base. This is why it is

important to look at both the level of activity, as well as the growth. From this perspective, there is

clearly a long way to go to return to a “normal” level of output. However there are legitimate concerns

that the supply response won’t happen quick enough to prevent further significant growth in prices and

rents that would impact on the competitiveness of the Irish economy. While we have highlighted that

rents are only a small percentage of total costs for service firms, they are much more important for

retail and industrial, while residential rents and prices have an important bearing on Ireland’s ability to

attract skilled migrants from abroad.

For us, the tardy response from the development sector can be put down to a number of issues:

Scale of price decline relative to costs: In many cases, prices and rents fell to the extent

that it became uneconomic to build. On the cost front, prices did fall but not to the same

extent, and have recently started to increase again. Indeed, construction costs are remain

relatively high in Ireland (see charts below). Given the faster recovery in Dublin,

development has only recently become economical again, thus we are seeing early signs of a

development rebound.

Cost of building a detached* house

Source: Turner & Townsend *described as “prestige”

Labour costs – Group 2 trades*

Source: Turner & Townsend *eg carpenter, bricklayer

Access to funding: The banking sector has been the traditional source of funding for

development in Ireland. While the sector is well along its recovery path, terms are

significantly different from prior to the crisis (for good reason).

Capacity in the construction sector: Due to the leveraged nature of the sector at the

peak of the boom, the scale of the collapse put a significant proportion of the industry in a

very poor financial state. Moreover, capacity in the sector is weakened by the fact that many

of the resources have left the country over recent years.

-40%

-30%

-20%

-10%

0%

10%

20%

30%

2008Q1 2008Q4 2009Q3 2010Q2 2011Q1 2011Q4 2012Q3 2013Q2 2014Q1

0

10

20

30

40

50

60

70

Jan

06

Jul

06

Jan

07

Jul

07

Jan

08

Jul

08

Jan

09

Jul

09

Jan

10

Jul

10

Jan

11

Jul

11

Jan

12

Jul

12

Jan

13

Jul

13

Jan

14

Jul

14

Index

Housing Activity Commercial Activity Civil Engineering Activity

0

500

1,000

1,500

2,000

2,500

3,000

3,500

PPP/s

q.

m

0

10

20

30

40

50

60

70

Poland UK Ireland Germany Netherlands US

PPP/h

our

Goodbody

02 Sep. 14 Page 35

The Construction 2020 strategy

In recognition of the fact that the industry continued to operate well below capacity and is responsible

for a significant proportion of those in long-term unemployment, the Irish Government launched its

Construction 2020 plan. This plan was in response to the recommendations by Forfás (Ireland’s policy

advisory board for enterprise and science) given in July 2013 outlining solutions to restarting Ireland’s

construction sector. The “2020” plan contains short to medium term actionable ideas to help accelerate

the recovery in the construction sector. However, there are no “magic bullet” solutions contained in it.

The plan contains 75 action points of varying timelines, but we would highlight four important themes in

particular:

(1) Funding: The most important constraint on the sector is funding. The plan accepts that some

Government initiatives will be necessary, including making funding available through the EIB or

the ISIF.

(2) Increased transparency: We highlighted this as an issue in our report last year, attributing

some of the volatility in the sector over the decades to the lack of full information. By Q4 2014,

the government is looking to publish a plan on how to enhance availability of data in the

commercial sector. Specifically, it looks to have a census of commercial property done by a

local authority. This follows on from the newly created Commercial Leases Database. In Q3, the

government is planning on having a review of construction and property data to identify gaps

and shortcomings followed by recommendations on how to improve on them.

(3) Smart legislation and planning reform: The Irish construction sector is often beset by

planning delays. In response to this, the government is looking to reform the process. However,

the government is keenly aware of failing during the boom years (Priory Hall for example) and

is planning, in lock step with smarter legislation, to risk-assess inspections. The government is

also looking at using the tax code to incentivise development in certain areas.

(4) Finally, the plan calls for NAMA to assist in development in the capital in particular. NAMA

currently has €2.5bn in planned property developments with a specific focus on SDZs, and

more specifically, the Dublin Docklands and Adamstown. NAMA will invest in developing both

residential and commercial property.

Goodbody

Page 36 02 Sep. 14

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specific recommendations or views expressed by me in this report.

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Goodbody

02 Sep. 14 Page 37

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