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Real Estate Needs To Rethink Returns As Rent Cap Holds Back Resi Investment

When it comes to rented residential real estate in Ireland, the game has changed. The days of short-term returns are over.

Ireland’s residential sector needs to be looked at as part of the social structure of the country and as a long-term play for stability-focused, long-term investors, according to Irish Residential Properties REIT outgoing CEO Margaret Sweeney.

IIP's Pat Farrell, Greystar's Miguel Fitzgerald, Ires REIT's Margaret Sweeney, Patrizia's Antonio Marin-Bataller, Harrison Street's Ben Chittick, Activate's Paddy McElligott and Tristan's Kristian Smyth.

Speaking as part of an international panel focusing on emerging opportunities at Bisnow’s Irish residential event on 9 November at Aviva Stadium, Sweeney questioned whether the perception of housing as another real estate asset class was realistic any longer, given the stringent 2% price cap placed on upward rent revisions. 

Much of the debate centred on the rental cap introduced on residential property, first introduced in 2016 but tightened in 2021. Some say it is fundamentally changing the nature of the sector.

“Real estate is not all the same. What's driving the sectors is different,” Sweeney said. “Residential is a very heavily regulated sector, and the debate is whether affordable housing is really about social structure and the longer term [as an investment class].”

She said the challenge for investors and developers was to accept that it was a heavily regulated industry and reset investment attitudes and expected returns around that.

“The challenge is around stability and predictability,” she said. “The 4% rent cap did work, but an overnight change to 2% was a political decision, and it’s very hard to operate in a government-decision-based market. In addition, the world of higher inflation and interest rates are here to stay for a while.”

Sweeney has been at the helm of Ires REIT for over six years and recently announced that she will step down in April after facing a difficult year in which Canadian activist investor Vision Capital has agitated for Ireland’s largest residential landlord to put itself up for sale to extract greater value.

This year, Ires has embarked on a €100M asset disposal programme, most recently completing the sale of 194 residential units in west Dublin to Tuath Housing in October for approximately €72M. The company said the proceeds would be used to strengthen its balance sheet and brought its loan-to-value ratio down to 42.1%.

After the disposals, the group now owns 3,734 apartments and houses for private rental in Dublin and Cork.

Sweeney pointed to interest rate volatility creating a lot of uncertainty in the Irish market and said that finding the most efficient cost of capital meant that residential owners need scale to operate, especially when there are risk-free returns on offer from cash investments at 3% to 4%. 

“Before we had to give the banks money to hold our cash, so people went into real estate,” she said.

She added that with the two main banks looking at real estate investment very cautiously, more private equity had come in, representing the biggest alternative debt source to finance and refinance schemes.

“We are in an environment that we haven’t had for 20 years. It’s a transition,” she said. “But the fundamentals and demand are very strong, and I think ultimately that capital does find its place. Residential real estate needs a longer view. Three years [as a time horizon] is probably done.” 

Tristan Capital Partners Managing Director Kristian Smyth said that with global bond yield rates continuing to suggest that interest rates will remain relatively high amid global instability, Irish real estate “needs to be in a fair amount of distress or have a good growth story” to become attractive and encourage more transactions.

“The government has dug itself into a hole and is now trying to dig itself out,” he said. "But ultimately, it’s about the [removal of the] 2% rental cap. But in reality, it won't happen in the next 12 months because that would be political suicide.

“Capital flows into real estate hit a high-water mark in 2021. What’s positive for residential is that there's definitely a recycling of offices into residential so there will be more money coming in and the fundamentals of demand are very strong.”

Activate Capital Head of Investment Paddy McElligott said he felt that the government had “fired as many arrows as they can and used their full toolkit.”

Despite concerns over the rent cap, especially amid high interest and inflationary conditions, he stressed that regulatory changes can take some time for companies to absorb and that it was still relatively early for the real estate industry to have fully adjusted.

“I would say leave the rent cap alone for a while and let it settle,” he said. “The macro level is tough, but the conditions are there to grow.”

Patrizia UK & Ireland Residential Investment Executive Antonio Marin-Bataller said that across Europe, core capital investment has all but stopped and is more active among the opportunistic and value-add investors.

“Investors are only going to spend core on the crème de la crème at good pricing, and if you look at markets like London and Sweden, they have repriced over 100 basis points,” he said. “Ireland’s fundamentals are still very good, with schemes fully occupied, but pricing needs to correct, and that needs to happen pretty quickly.”

With rental caps common in Europe, he speculated that the 2% restriction was too tight for international money to come in. Investors would need to see evidence of very attractive returns.

“We are going through a significant correction. The cost of capital and debt is very expensive,” Marin-Bataller added.

Greystar Ireland Investment Director Miguel Fitzgerald questioned the purpose of the 2% cap, saying it was positive for existing tenants but “very detrimental to the asset class and the investor, as we can see that with no activity in the private rental sector.”

He argued that the cap should apply to the person, not the property, and pointed to the fact that in some apartment blocks, neighbours might be paying rental differences of a thousand euros per month depending on when they took up their tenancy.

“For investors, the dates of tenancies are like vintages of wine, where some invested in great years and others in much worse vintages,” Fitzgerald said. “Investors don't have to be here. Their money can end up elsewhere if we are not attractive enough, and at the moment, we are not because of the rent cap.”

One of those overseas companies that has been active in Ireland as an alternative debt provider is U.S.-based Harrison Street. Managing Director Ben Chittick said that while he understood that the rent cap had been introduced as protection from “skyrocketing rents” it had only succeeded in helping to exacerbate the shortage of available properties.

“The purpose has put us backwards. It is not progressive,” he said. “The current theme is uncertainty. Investors need to know they have an exit into a market of scale. But all the pieces are dysfunctional. We need a correction to get things moving, then things will start to unlock. Right now, everyone is looking at the same cloudy crystal ball.”