The below is the text of an article which appeared in the Sunday Times on 20th November 2022. We have updated some figures to keep the article current.
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These are strange times in the Dublin property market. IRES REIT plc, the largest landlord in Ireland, and listed on the Irish Stock Exchange, has seen its shares decline some 41% from a peak of €1.83 back in December 2019 to €1.07 today. At this price, the shares trade at a 36% discount to the actual market value of its 4,000 rented apartments portfolio of €1.68 a share.
And the shares offer a tasty dividend yield of 4.9%, compared to the yield of 2.9% on offer from an Irish Government 10-year bond. The income from such a bond is fixed for the 10-year period whereas the dividend on IRES REIT’s shares can grow, should rental income grow.
So, what’s up?
IRES REIT stands for Irish Residential Real Estate Investment Trust. An investment trust is simply a company structure, and in this case a company that owns 4,000 individual apartments in Dublin. Provided the company meets certain legal requirements, it is not subject to income or capital gains tax. An investment trust must pay out at least 85% of its net income by way of a dividend each year, and this income is taxed in the hands of the investor.
Because IRES REIT’s shares trade on the stock exchange, should there be an excess of sellers, as is currently the case, the shares become decoupled from the underlying value of its property portfolio, or its net asset value.
We can see three separate risks.
First up is the company’s debt, which represents 43% of its assets with 70% of its debt at floating rates, which means that its interest bill is already rising as the ECB raises interest rates. Along with rising interest rates, rental growth is capped in Dublin, and operating costs are also rising, thus putting pressure on earnings (and the dividend).
Next up is political risk. And it’s not insignificant. Should Sinn Fein win the next election who knows what draconian policies they could adopt in an attempt to control rents and make housing more affordable. No wonder the number of ‘for sale’ signs have been picking up recently!
And thirdly, rising interest rates and rising unemployment can be expected to at least soften up property prices in the capital given that they are at significantly elevated levels relative to incomes.
Against a backdrop of rising interest rates, property and share prices often fall in order to offer a higher yield (return), which then enables them to continue to attract investor interest.
In other words, rising interest rates are bad news for property investors, affecting both their earnings and asset values.
So, investors in Irish property listed on the stock market are simply looking forward. These three likely concerns may or may not come to pass, but that’s what the market does. It anticipates possible risks.
From an investment perspective, however, the risks in IRES REIT’s property portfolio and rental income stream are exactly the same as the risks all investors that own actual apartments in Dublin face.
The majority of people who own an apartment for investment purposes probably have a mortgage (debt) and many will mostly have a higher proportion of debt against the property compared to IRES REIT.
They are also likely to have floating rate debt, so that their interest bill is already rising. And they own property at similar valuations to IRES REIT, so that they have the same valuation risk as IRES REIT and investors in IRES REIT shares.
The person with cash to invest today, of course, now has a choice. She can buy a single apartment as an investment at elevated valuations in a single location with debt getting more costly and faced the same political risks.
Or she can buy IRES REIT’s shares, which offer far better diversification (4,000 apartments compared to one) and have already discounted some of the aforementioned risks by 36%. And she can invest as little or as much as she wishes and without the need to use any debt.
Irish people tend to believe that shares are riskier than physical property. This is simply a mis-informed view. I’m not saying shares in IRES REIT are risk free just because they look cheap versus the alternative of buying a physical property. What I am saying is that if you want to own Dublin property, IRES REIT’s shares offer the better alternative, and by a significant margin.
Does a 36% discount adjust enough for the risks at hand? We might now do some hand-waving and, like a good professor, say “the remainder is left as an exercise for the reader.”
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