A couple of weeks ago, this column considered the fragility of China’s property market and whether a collapse in China could undermine Ireland’s dysfunctional property market. Many argue that Irish property will not falter because of the fundamentals, characterized by demand, a growing workforce and property scarcity. However, as evidenced by the large number of international real estate funds active here, property is a global asset class and global events can have an outsized impact on the local.
Compared to 2008, Ireland is more connected to the global real estate market because global capital is here. The property market and its players have changed profoundly since 2008. In many ways it is unrecognizable from the Galway Tent and Ghost Estate fiasco. Analyzing the current market in terms of the Celtic Tiger is similar to the generals who fought in the last war. We are dealing with a different beast. The transmission mechanism, the journey from problem to crisis, that would unfold in the event of a global property reorganization, will be completely different, not the same journey from domestic overheating to bankruptcy that we witnessed in 2008.
In the last bust, retail banks ran out of money first, borrowing from the private sector, causing the market to sell off, impacting the real economy in the end. This time, retail banks are not as involved as private sector money. This is largely made up of leveraged funds that operate as bond market investors, taking out low-interest loans from investment banks, wealthy private individuals, private equity, and other investment funds to buy blocks of flats. The last decade of near-zero interest rates has made this trade easy. The objective is to play the difference between the low rate of indebtedness and the highest yield of rents. As long as property prices are rising, these funds can keep their investors happy with capital gains.
It’s about interest rates, unlike last time, when it was about income.
In Ireland, more than €5 billion was invested in Irish commercial real estate in 2021. Institutional landlords invested more than €1.7 billion in Ireland’s residential sector. Sherry FitzGerald estimates that the funds have invested close to €7bn in the Irish residential property market since 2011, and €3.7bn has been invested since 2018. All this money is playing the return game. According to commercial property services and investment firm CBRE, returns in Ireland for various property types in the second quarter of 2022 have declined. Based on rents, multi-family residential net yields are 3.6%, high-end offices are 4%, while purpose-built student housing is 4.5%, and high-end retail retailers are 4.5%. first level of 4.5%.
The market is finely balanced as the interest rate cycle swings higher. Obviously, the returns on newer real estate investments will be substantially lower as properties become more expensive to purchase.
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This time the cracks will appear first in these private funds who, when pressured by rising interest rates, will be forced by margin calls to generate cash for their financial backers, forcing them to sell properties to get that cash, which will cause prices to rise. fall. Interestingly, unlike in 2008, because the average punter is not an owner this time but a renter, the resulting negative equity won’t be as disastrous, but it will feel uncomfortable, almost recessionary. In the longer term, anything that forces property prices down is a good thing for workers, not so good for homeowner wealth and, in particular, multiple homeowners or property-linked pensions.
So how does this play out? First, don’t look at the market through the lens of the last cycle. Second, it’s all about interest rates, unlike last time when it was all about income.
This week, as the Kremlin realized it has a serious fight on its hands, one it stands to lose, financial markets realized that fighting inflation will be a long, hard job with serious implications for interest rates. . During the week, many had “expected” US inflation to show signs of falling, meaning interest rates would not need to rise too high.
It’s just the credit cycle, as predictable as the weather. It is not necessary to pinpoint the day when the temperature drops to know that winter is coming.
Although leading inflation indicators are on the right track (oil and food prices are retreating as some global supply chain issues are ironed out), US core inflation remains above 6 %. The Federal Reserve is now expected to raise rates by another 1 percent in the coming weeks, taking them to 3 percent. US interest rates are now rising at their fastest pace in forty years. Imagine what would happen if the Federal Reserve decided to raise rates above the rate of inflation to actually throttle inflation. US interest rates of 5 percent would be curtains for private equity business. It may not go that high, and no one can be sure how things will play out. What we do know is that there is a huge amount of debt, people can’t afford higher rents, and the global housing market is intricately intertwined.
According to the financial company MSCI, the size of the global professionally managed real estate market stood at $11.4 trillion in 2021, up from $10.5 trillion in 2022. The market is estimated to be divided into the following geographic lines, with the Americas accounting for some $4.6 trillion (40 percent); Europe, the Middle East and Africa (EMEA) for $3.8 trillion (34%); and the Asia-Pacific (APAC) region making up the remaining $3 trillion (26 percent). The possibility of contagion is obvious.
Today, the return on prime office space in Dublin (4 per cent) is still trading at a premium to other European hubs such as Munich (2.65 per cent), Paris (2.85 per cent), Amsterdam (3.10 percent) and Madrid (3.25 percent). percent). As debt costs begin to rise with central banks around the world raising interest rates, each market drags the other down like men on a rope falling off the cliff.
Once the move up in interest rates takes hold, cash will become king. The debt will be a death wish. Those with leverage will go bust because they will be forced to raise cash to cover their investors’ margin calls. Initially, they will try to sell the underperforming stuff, like their German portfolio. But who will want it? Ultimately, these funds will have to sell their “good” assets to raise money to cover the losses on the “bad” assets. Thus, good turns bad in a credit crisis. The global game of property goes from the return in the return investment of the investment. Real estate assets are sold, prices plummet, funds go bankrupt, the former captains of the universe come back to earth, and we start anew.
It’s just the credit cycle, as predictable as the weather. It is not necessary to pinpoint the day when the temperature drops to know that winter is coming. Time to finish.