The market has been adjusting to a higher interest rate environment, which has challenged asset values due to rising debt costs and increased opportunity cost of capital. For instance, government bonds have become a viable alternative for yield-seeking investors, offering passing income that rivals real estate, albeit without the same inflation protection.

In this challenging environment, asset managers have focused on strengthening their balance sheets. This includes selling minority stakes in large assets/portfolios, injecting additional equity where available from sponsors, and undertaking property sales to raise equity, particularly for funds needing to satisfy redemption requests. Consequently, we have seen several assets on Grafton Street change hands, attracting high-net-worth individuals who seek yield amidst eroding cash balances due to inflation.

Savills Investment Management estimates that 45% of UK CRE debt will need refinancing in the next two years, indicating the scale of refinancing required in the market. Asset sales will be inevitable for non-stabilised assets with upcoming financing events where the holder cannot plug the funding gap. However, there is strong demand for new lending for the right assets, as the debt element of the real estate capital stack is an attractive defensive investment in the current environment.

Funding availability is highly thematic, and we are witnessing the market bifurcate in an unprecedented way, leading to a widening dispersion of returns between assets. Office investments exemplify this trend, as ESG considerations and post-COVID demand preferences for CBD locations concentrate investor demand on a more narrow, focused market segment.

In recent years, beta-led investment strategies worked well in a supportive monetary environment, where asset values rose across the board. However, contemporary investment selection must be backed by a detailed thematic story underwriting rental growth even in a challenging economic landscape.

The industrial market is a prime example of a sector offering such secular opportunities, as long-term demand drivers such as e-commerce, Brexit, and occupier consolidation provide mitigation against economic cyclicality.

Promising prospects for rental growth ensure that rents reprice in line with general inflation, protecting the value of cash flow streams. Capital values are also safeguarded by rising replacement costs in an inflationary environment, while increased financing costs make new construction more difficult. This latter aspect acts as a barrier to entry for new supply in an already supply-constrained market.

Inflation protection has always been an attractive feature of real estate. Long-run data from the United States analysed by Apollo demonstrates that real estate returned an average of 11.0% during inflationary periods, compared to 4.2% for equities and 2.5% for bonds. While the current market is undeniably challenging, real estate still outperforms other assets over the long-term during inflationary periods.

In summary, the Irish commercial real estate investment market is facing a difficult environment, with higher interest rates and increased competition from alternative income driven investments such as bonds. Asset managers are taking various measures to strengthen their balance sheets, and investor demand is becoming more focused and thematic.

Nevertheless, the real estate market remains resilient, offering inflation protection and outperforming other assets during inflationary periods. Investors should remain vigilant and adapt their strategies to navigate these challenges successfully.

John Ring is Director of Research at Savills Ireland