While any economic downturn or uncertainty will have an indirect effect on property, as will any interest rate increases, there is the fundamental premise that property is a resilient asset.
The long-term nature of leases with five-yearly rent reviews generally insulate against any sharp economic shocks. A secure income stream from a well-located asset can act as a hedge against investment volatility.
Property is also seen as a specific hedge against inflation. Rising prices will generally include rising rents. In some instances, leases include rents linked to inflation and also to turnover. These elements protect the property investor against inflation.
This protection is especially relevant right now when one considers that inflation in Ireland has risen over the past year to an annual level of 5.6 per cent in February, up from the annual figure of 5 per cent in January. At a Eurozone level meanwhile, the estimate for annual inflation to February is 5.9 per cent up from 5.1 per cent in January. For March, the figure is expected to climb to as high as 7.5 per cent.
This is getting close to four times the Eurozone target of 2 per cent per annum. The rising inflation rate however is largely attributed to rising energy costs with further pressure on food and commodity prices due to the ongoing war in Ukraine.
Despite this rise in inflation, the ECB has so far resisted the temptation to tighten monetary policy. This reflects a view that inflation is largely cost-driven and, as such, a tightening of monetary policy is unwarranted at this point.
While the ECB has not altered its key interest rates and has stated that it does not expect to increase rates until “some time after the end of its asset purchase programme has ended” (currently expected to be in Q3 2022) this position is subject to revision and will depend on the evolution of economic and monetary conditions over the coming months.
The war in Ukraine
Monetary policy at the Eurozone level is conditional right now on the evolution of the conflict in Eastern Europe. Commenting on this in a recent statement, the ECB said: “The risks to the economic outlook have increased substantially with the Russian invasion of Ukraine and are tilted to the downside. While risks relating to the pandemic have declined, the war in Ukraine may have a stronger effect on economic sentiment and could worsen supply-side constraints again. Persistently high energy costs, together with a loss of confidence, could drag down demand more than expected and constrain consumption and investment.” (ECB, March 2022)
Interest rates
Notwithstanding the comments of the ECB we have seen an uptick in rates being quoted by lenders for property deals. This has been through increased margins reflecting the perceived risk and uncertainty. This will have an impact on the prices debt-backed investors can pay. Fixed interest rates can help hedge the uncertainty of future increases.
For cash investors the yield will be a call on the opportunity cost of investment and the attractiveness of property versus other opportunities. The gap between bond yields and property returns is however in excess of 400bps thus providing some headroom in this regard.
Market activity
Having said this, one would still expect that the current, heightened uncertainty would lead to some form of stalemate as investors take stock. This doesn’t appear to be happening with the feedback from MIPIM (the European Property investment get-together in Cannes) being that it was a case of “business as usual”. Property is still in demand as an investment and in particular Irish property is seen as a safe bet. On the ground deals are still progressing.
For instance, it has been reported that the Canadian investor Brookfield are acquiring Hibernia Reit for €1.1 billion while Blackstone are weighing the purchase for €1.1 billion of the European headquarters Johnny Ronan's RGRE is developing for Facebook in Ballsbridge and for Salesforce in Dublin's north docklands.
After two years of Covid-19 lockdowns, there would appear to be a view that we live in an uncertain world, and that the war in Ukraine is just one more uncertainty that will pass. After two years of a pandemic there is pent-up demand with many investors having cash on their balance sheets that they intend to deploy.
Neither inflation nor war are issues that we have had to deal with for some time however history has shown that property plays a valuable role as a hedge against these and other forms of uncertainty. Demand for Irish property remains strong despite all of the headwinds. So while the precise economic impact of the conflict in Eastern Europe is in the realms of the unknown at this point, the property investment sector remains active.
