As we pull clear of our economic troubles it is interesting to reflect on which industries lost out most heavily during Ireland’s great recession....
As we pull clear of our economic troubles it is interesting to reflect on which industries lost out most heavily during Ireland’s great recession. Admittedly, given that the crash subtracted nine per cent from overall GDP, this is a hotly contested space. However there is no doubt that retail was among the hardest hit sectors.
Between September 2007 and March 2012 overall employment in Ireland fell by 16%. As a result 345,000 people lost their incomes and pay levels were hit across the public and private sectors. In addition the banking crisis provoked an abrupt withdrawal of consumer credit while higher taxes, which were necessary to fund the fiscal adjustment, drove a wedge between gross incomes and take-home pay. What these numbers don’t capture, however, is the psychological impact of the crisis. At its lowest point the consumer sentiment index had fallen by 63% from its peak. Meanwhile the gross savings ratio rocketed from 3.9% to 18.1% as households hoarded what money they had and reduced debt in the face of an uncertain future. All these factors had a profound impact on consumers’ spending power.
Inevitably this impacted heavily on the retail trade and, it follows, on the retail property market. According to IPD, a reputable source of commercial property data, retail rents dropped by 50% during the crash while capital values collapsed by 72%. But now something quite interesting is happening. Spurred on by a general sense that the consumer economy has turned a corner, investors are once again in the market for Irish shopping space. From a position where commercial property investment had all but ceased in 2011, more than €4.5bn of income producing real estate was traded last year – a new record for the Irish market. Shops accounted for one quarter of this and, with NAMA and others preparing to bring major retail portfolios to the market over the coming months, this proportion is likely to rise dramatically in 2015.
Ultimately investors’ willingness to pay for these assets will depend on their perceptions about future growth in retail rents. On the basis of simple intuition the outlook seems positive with average earnings, disposable incomes, personal consumption, retail sales, consumer sentiment and employment all now moving on an upward trend. At the same time households’ spending power is being boosted by low interest rates and a sharp fall in energy prices.
However the real challenge for investors is to understand how this general improvement will impact on retail rents. From a long list of potential influences it is not immediately clear which macro-economic factors materially impact on retail rents and which are just noise. Likewise, intuition alone does not provide an accurate gauge of how sensitive rents are to the key macro-economic drivers, or how long it takes for changes in the economy to feed through to rental growth.
To shed light on these issues we have analysed the statistical relationships between retail rents and a range of potential explanatory variables over the last 18 years. Perhaps surprisingly, this research shows that earnings and disposable incomes do not have a very big influence on retail rents. Instead, employment is by far the most important factor, with a 1% rise in jobs growth bringing about a 0.9% increase in rental growth 15 months later. A reasonable interpretation is that the security of income that comes with having a job is much more important than the size of that income in driving consumer demand and, ultimately, retail rents.
The analysis also finds that consumers’ perceptions about how their finances have changed over the last 12 months strongly impact on retail rents. Indeed this measure is more important than the consumer sentiment index or any of its other sub-components. The implication is that people need evidence of a sustained improvement in their finances before making changes to their shopping behaviour which eventually drive retail rents.
If one benefit of the research has been to sharpen our understanding of the factors that are important in driving rents, another is that it provides us with a mathematical model for forecasting the retail rents index. Rents in the prime high street and shopping centre locations have been growing strongly for some time. However performance varies greatly by region and store type, and the overall IPD index – which includes a significant weighting of provincial shops – only returned to positive growth in Q4 2014. This recovery has carried through into Q1 and, according to our model, we should see further modest growth in the index until mid-2016 at least. Within this improving baseline scenario, however, we can expect to see some schemes out-performing while others lag the market.
Dr. John McCartney is Director of Research at Savills. Dr. David Duffy is Senior Research Officer at the ESRI. They presented their paper - What Explains Retail Rents in Ireland? - at the Annual Conference of the Irish Economic Association on 8th May.