Irish house and apartment prices continue to rise yet IRES REIT’s share price continues to languish. This Featured Article attempts to explain why and whether the shares represent a value opportunity or hidden risks yet to crystallise.
IRES REIT stands for Irish Residential Real Estate Investment Trust, and it owns circa 3,700 apartments principally in Dublin. An investment trust is a company structure availing of special tax status that exempts the trust (or fund) from paying taxes on any capital gains and/or rental income.
Chart 1 highlights the growth in Irish house prices and average incomes of those employed since 1971. Over that 52-year period, the average Irish house price has risen by 7.7% compound per annum while the average income of those employed has risen by 7.1% compound per annum.
Chart 1 is a semi-log chart and is a more accurate way of showing the proportional movements in Irish house prices and incomes over time. Clearly, rising house prices are principally fuelled by rising incomes in society over time, although other factors such as interest rates and demand/supply imbalances also come into play from time to time.
The 52% peak-to-trough decline in the average Irish house price from €348k in late-2007 to €165k by late-2012 is visible in Chart 1 and was a rare setback in Irish house prices. By end 2023, however, the average Irish house price was at a new peak of €379k.
It might surprise you, then, to learn that the value of IRES REIT’s apartment portfolio (or net asset value per share) has declined by 25% since June 2022 defying the ongoing rise in Dublin apartment prices.
There are, of course, two markets operating simultaneously in the Irish house and apartment market.
There is the institutional market, driven by the availability of a rental yield (the rent as a percentage of the apartment price), and there is the retail market driven by peoples’ desires to own their own homes and any demand & supply imbalances.
Institutional buyers of apartment blocks are, rightly, demanding a higher rental yield to compensate for the rise in Eurozone interest rates through 2022 and 2023. Chart 3 highlights this point well.
As Irish long-term interest rates rose from below zero in mid-2022 to just over 3.0% in early 2024, the rental yield available from the Dublin apartment market rose to reflect this.
A rental yield can rise in two ways: (i) through the growth in rental income; or (ii) by a decline in apartment prices. The Government-driven rental caps in place in Dublin rule out much rental income growth, so that prices for institutional buyers have had to decline in order for the rental yield to rise. Today, the net rental yield on IRES REIT’s residential property portfolio is 5.1% and compares to an interest rate (yield) on an Irish 10-year Government bond of 2.52%.
A Government rental cap policy starves the providers of capital of any growth in the rental income – while inflation marches ahead – and has led to an exit of capital from this area of Ireland’s investment markets. Long-term institutional buyers of Dublin residential property are sending a clear signal. They will not provide capital, they will not buy, so long as Government interference continues.
To make matters worse for IRES REIT’s shareholders, its shares are trading at a 28% discount to this reduced net asset value (Chart 2 above). Clearly, investors in IRES REIT’s shares are equally despondent about Government policy and the long-term implications for an operator like IRES REIT.
All is not lost, however, and we think the 28% share price discount to net asset value represents an opportunity for patient investors. As outlined in its recent Strategy Review, the Board of IRES REIT has committed to selling 8% of its portfolio into the retail market on an apartment-by-apartment basis over the next 3 to 5 years when individual apartments become vacant.
Management can achieve prices well above the stated net asset value of €1.26 a share. This gives the Board the opportunity to generate nearly 25% of its market value in cash, which can be used to pay down debt and buy back shares at a substantial discount to net asset value, if the shares continue to lag net asset value to such an extent. This would lift the net asset value per share for remaining shareholders as well as likely narrowing the discount at which the shares trade compared to net asset value.
To answer the question posed at the outset of this article, we don’t see a lot of risks-yet-to-crystallise in IRES REIT’s shares. The trust owns a quality, diversified portfolio of apartments in Dublin where demand continues to outpace supply, has conservative levels of debt (at 45% of gross assets) and the shares trade at a substantial discount to the on-the-ground apartment prices. And, for the patient investor, a 4.8% dividend yield on a share price of €0.90 pays one to wait for the likely eventual reversal of a populist but ill-thought-out Government policy.
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Rory Gillen
18th Sept 2024
