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PROPERTY INDUSTRY IRELAND Opening Statement to the Oireachtas Joint Committee on the Environment, Culture and the Gaeltacht Tuesday, 23 September 2014 Commercial and Domestic Property – Supply and Demand 1. Introduction: Property Industry Ireland Property Industry Ireland (PII) was founded in 2011 as a forum for debate and policy development amongst businesses operating in the Irish construction and property sectors. Working as a not-for-profit think-tank, PII is a member-led representative organisation which works to drive innovation in construction, property and the built environment. In addition to our policy-formulation work, we provide briefings, discussion forums and conferences to bring together business leaders, academics, and representatives from charitable and public sector agencies, to promote cross-sectoral knowledge-sharing. PII member firms represent the entire spectrum of the property sector, including legal and accountancy practices, property and asset managers, developers and contractors, as well as professional practitioners such as planners, architects, surveyors and engineers. PII is an affiliate of Ibec, the body representing businesses working in Ireland, giving an unrivalled access to economic and market knowledge. Membership of PII is open to all businesses with an interest in the Irish property and construction sector. Commercial and Domestic Property: Supply and Demand 2. The Property and Construction Sector The Irish property and construction sector grew rapidly during the Celtic Tiger eventually accounting for around 20% of Irish economic activity. Following the collapse of the banking sector, construction industry output fell relative to the economy, so that by 2013 it was worth less than 7% of economic output. House prices and the value of commercial property also fell rapidly, sending a profound and long-lasting shock across the economy and society. In mid-2007, direct employment in construction stood at 273,900. By the same period of 2014, employment had fallen to 106,300. Indirect employment in businesses supporting construction and property development activity has been equally hit. A number of measures have been put in place by Government in an attempt to stabilise and grow the sector with the aim of output reaching 12% of economic activity – the European norm for a sustainable construction sector within a healthy economy. Budgets in 2012 and 2013 have attempted to promote investment in Irish property through reform of Capital Gains Tax and stamp duty, and there has been a move from transaction-based property taxes to annual property taxes. Local government funding has been reformed to make local authorities less reliant on levies on new development. Legislation to support the introduction of Real Estate Investment Trusts (REITs) has had a notable effect of encouraging new sources of investment into the sector. The general recovery in the economy, particularly domestic consumption and the increase in employment, has assisted in growing transactional activity in the property recovery. Renewed economic activity and consumer appetites have also revealed supply-side problems. In 2014, Government published “Construction 2020” following an earlier Forfás strategic report into the future of the construction sector. Construction 2020 sets out a number of actions to reform the governance of the construction industry and to build an evidence-based property sector. Over the medium-term the strategy seeks to resolve mismatches between supply and demand for residential and commercial property through targeted infrastructural investment, reform of planning, and partnership between State agencies and the property sector. This briefing note sets out the current state of the commercial and residential property sectors, from the perspective of supply and demand issues. 2 Commercial and Domestic Property: Supply and Demand 3. Commercial Property 3.1 Demand Following a deep crash in 2007, demand for Irish commercial property sector has rebounded in recent years, particularly in the Dublin market. The Irish commercial property market was not unique in Europe in experiencing declines in prices and rents from c. 2007, but it has been a leader in harnessing increased investor activity, and as a result of domestic and international investment and economic expansion, the sector has experienced recent strong demand, especially in the office market. Investment in the commercial property sector totalled €1.9bn in 2013 (of which 90% was in Dublin; 60% of total investment was in the office sector. 57% of take-up of office space in the Dublin CBD was by tech firms). Current forecasts are for total investment in the market in 2014 to exceed the 2006 peak of €3bn. Compared to other investments, returns on Irish commercial property have been relatively impressive. According to latest Investment Property Databank (IPD) analysis, the Irish office market has driven an increase in returns over 2014. IPD forecasts further growth in 2014 onwards. Office rents have increased by 22% over the last year, compared to an overall increase of 12% overall in the commercial property sector. Office capital values have increased by 33%. According to a recent Goodbody report (“Irish Property – from stabilisation to recovery” September 2014) the increase in demand for commercial property is underpinned by better than expected macro-economic recovery. The extent of this improved demand should, however, be seen against a wider backdrop: (1) volatile property cycles, including increases in investment following deep reductions in prices, are normal, both in Ireland and overseas; (2) the recent rebound should be kept in the context of the extent of the crash which preceded it; (3) the mismatch between supply and demand is having a squeezing impact; (4) the relatively healthy yield compared to government bonds has resulted in an international search for yield. Domestic policy issues such as the future of “Upward Only” rent review clauses, as well as taxation reform in future Budgets and the future investment strategies of the new REIT sector will continue to have an impact on the value of transactions and the volume of take-up in the year ahead; the immediate impact of any increase in take-up will be on vacancy rates. 3 Commercial and Domestic Property: Supply and Demand Estimates for vacancy in the Dublin CBD vary between 13% and 17%, with vacancy levels falling by around 7-10% since 2006, especially in prime areas. The Goodbody report, using estimates of current vacancy rates from recent Savills and Lisney analyses, expects vacancy rates in Dublin to fall to c.10% by 2016. This shortage of prime, quality office space in key areas will have an impact on future rents and prices. It is also likely to have a serious impact on the investment opportunities for some businesses, particularly Dublin-based tech firms who have been the most active in taking up new space. 3.2 Supply Despite strong growth in demand, investment and take-up, new supply of new commercial property – especially offices – remains subdued. A lag between increased demand and increased supply is a normal part of the economic cycle, with new development only coming on stream when schemes become financial viable following a rise in rents and improvement in yields. Latest analysis of supply suggests only modest new development activity in 2014, with only 2 new office projects underway in Dublin. Given the often slow financing and planning processes, there will be no increase in supply in the commercial sector until 2016. Not until prices and rents rise across other urban areas will financial viability reoccur, and the growth in supply will begin to take place. According to the Goodbody study, there are four issues which will determine the point of financial viability and therefore the increase in supply. (1) Access to domestic sources of finance and the extent of reliance on bank lending to support construction activity; (2) Capacity within the developer, construction, design and contracting supply-chain to build out large office/commercial property developments; (3) the future direction of NAMA and the speed and nature of decisions on access to finance and sales by NAMA, and (4) the speed of charting a new development through the planning and appeals process, especially in Strategic Development Zones (SDZ) where the bulk of new development will take place in the short-term. 4 Commercial and Domestic Property: Supply and Demand 4. Residential Property Many of the problems facing the residential property sector in 2014 are legacies of the Celtic Tiger and the ensuing crash. Issues such as negative equity, homelessness and ghost estates are, in part, a legacy of a prolonged mismatch between housing supply and consumer demand. Increasing household formations, the removal of bed-sits and increased building standards, have all had an impact on the recent increase in house-prices and shortages of property in some urban areas. As of July 2014, average house prices in Ireland are 42.3% lower than their highest level in September 2007. In the past year, national house prices have increased by 13.4% with the strongest growth seen in the Dublin apartment sector where prices have increased by 26.3%. The speed of price increases has not been uniform, and Ireland currently has a continuing split between movement in prices in Dublin, other urban areas, and in rural areas. While the presence of a recovery in prices will be welcomed by some homeowners in negative equity, the speed at which prices are growing is putting pressure on the private rental and social housing sectors. Affordability of property, especially in urban areas, has eroded as house prices have increased faster than take-home pay. Students, in particular, are facing the consequence of increased rents in Irish cities, and it is widely recognised that Ireland’s social housing sector has suffered as demand for services has increased as the exchequer funding of social housing has been cut, and Part V delivery has been undermined by low private sector development levels. 4.1 Demand As a result of the decline in supply of new houses, reluctance by many homeowners to put their house on the market during a period of rising prices, and improving demographics, demand for available new and second-hand accommodation is increasing. According to the Housing Agency, 80,000 residential units are required across urban settlements between 2014 and 2018, with an immediate need for over 9,000 units to serve Ireland’s urban areas alone in 2014. Demand for residential property is not evenly spread across Ireland. The Housing Agency estimates that 7,500 units per annum are required in the Dublin region urban settlements between 2014 and 2018. Demand is also strongest in other urban areas – 4,400 units are 5 Commercial and Domestic Property: Supply and Demand needed per annum in urban Cork, 2,300 are needed in Galway and 2,600 are needed each year in Limerick. Other commentators and researchers have made estimates for housing need over the medium-term. The Economic and Social Research Institute (ESRI) estimates that 10,000 to 12,000 new homes are needed nationwide per year up to 2015. The Society of Chartered Surveyors Ireland suggests that demand will increase to between 20,000 to 25,000 new units per annum from 2016 onwards. Irrespective of which figures are used, the gap between supply and demand has already become visible in the speed of house-price increases. Demographics and population movement within Ireland will continue, and will determine the location, size, price and type of housing which is demanded. Housing waiting list figures and the recent increase in homelessness shows the pressure on the social housing sector. The homelessness charity Threshold suggests there are 89,892 households needing Social Housing support, and an annual need for 6,000 new social houses. There is an immediate requirement of 2,700 units to resolve the current homelessness problem. Reliance by the sector on exchequer financing and Part V contributions have proven unsustainable during a period of low levels of development and a weak exchequer position. 4.2 Supply The growth in house prices and increases in rents has been a direct result of low levels of housing activity. From a peak of c. 93,000 units in 2006, there were only 8,301 units completed in 2013. Leading indicators of future housing supply such as planning permissions and commencement notices forecast continued supply-side weaknesses in the market. In 2007, 72,661 planning permissions were granted. In 2013, only 21,288 were granted. While planning permission figures for 2014 to date show a small increase compared to last year, they too anticipate continued low-levels of new housing development, far below the levels of demand. In the first half of 2014, there have been 4,800 new housing completions, and current estimates for completions for the year as a whole, based on commencement notices submitted to local authorities, suggest 8,400 new houses will be completed in 2014. Given continued delays in project financing and planning, it is unlikely there will be any significant numbers of properties coming onto the market before 2016. 6 Commercial and Domestic Property: Supply and Demand 5. Recommendations for Reform In its 2014 pre-Budget Submission “Delivering Ireland’s Property Needs” Property Industry Ireland has set out a number of small measures which, cumulatively, could have a positive impact on closing the supply-demand gap; these reforms would bring some measure of calmness to the market, and provide stabilisation for the public, private and commercial property sectors. 5.1 Social Housing €50m (min.) annual capital injection from sale of surplus state property – potential for 1,100 extra units per annum using existing financing models Harness private institutional investment: REITs and private investors Graduated Part V: Early engagement, enhanced role for voluntary sector Improved Asset Management: Remove voids and invest in refurbishment Why collect VAT or levies from development of social housing? Why not use existing sites held by local authorities? 5.2 Private Residential Property Reduce VAT on construction of residential property (currently 13.5%) to 9% Enforce reduction of development contributions from peak-era rates Reduce windfall tax (currently 80%) to 33% Planning reform to prioritise student/retirement accommodation Less doctrinaire with regard to use of vacant commercial property for residential/disabled 5.3 Commercial Property Approve Pre-let agreements for IDA Ireland Accelerate investment to resolve infrastructure bottlenecks Promote use of ISIF and EIB to complement exchequer funds Reform public procurement to facilitate SME employment 7