'For sale: development land with agricultural potential' is the latest joke doing the rounds in the property market.
The value of a site is determined by the type and number of buildings that can be built on it and the demand for those buildings – houses, apartments, offices and so on. Ireland has changed dramatically over the past 24 months with global economic uncertainty, people losing jobs, and investor confidence shot to pieces. Therefore, in many cases, the most economic use of the land today will be on the basis of a considerably lower density than that envisaged at the height of the market. This has, and will continue to have, a very significant impact on values in the future.
The value of a site must take into account end-user demand. During the boom, demand for property reached record levels as large-scale immigration resulted in a rapidly growing population. High-density schemes were built on the peripheries of towns and cities to accommodate the growing population. Following the rapid slowdown, the demand for high-density apartments has evaporated, with buyers in these areas now able to afford standard two- and three-bedroom houses. With a large overhang of unsold apartments, some of the existing high-density schemes in peripheral locations will have to be priced to attract investors on the basis of long-term returns, or for local authority housing requirements.
The land market has seen a number of booms over my 28 years in the business but the rule book for site valuation was thrown out in 2006-2007. Although this was largely due to the free availability of credit, it was also driven by demand from private investors to get into the development market. Non-property investors rushed into speculative development because the potential returns were higher than buying fully let income-producing assets. In many cases they did not realise the extent of the risk they were taking by investing in an asset with no cash flow to service their debt. It was too easy. When values started to decline, the value of the land fell exponentially and their equity was wiped out. Many of these sites are years away from yielding an end product or revenue and are now largely uneconomic to develop given the prices paid.
Development land values are in freefall, and the big question is where to now? We need to go back to basics. (See table above)
If you take a typical house value in 1995 versus 2006 (say €150,000 in 1995 and €400,000 in 2006), building costs, finance, fees, levies and so on largely increased in line with inflation. In 1995, permitted densities averaged 10 houses to the acre; however by 2006 the densities had risen to a minimum of 20 units per acre. The rise in densities and in end-unit sales figures increased the site value from €375,000 per acre in 1995 to more than €2m in 2006. Most if not all of the uplift in the value of the completed development was being added to the value of the site. This situation is now being reversed and land values must fall to a level at which low-density schemes can be developed profitably.
There is huge uncertainty in the market now and developers and builders who are prepared to build – and there are some appearing – are looking for high margins to cover their additional risk. Similarly, in the office market, there has been a huge movement in rents and yields.
The convergence with the euro in 2000 reduced interest rates significantly. Yields tracked interest rates down to unprecedented new lows. Again, office developers were buying sites reflecting no risk and looking for very ambitious densities, with record rents. We are now looking at office site value decreases in the order of 50%-70% from peak to trough, based on current rents, yields, and realistic densities.
Nama has been debated extensively over recent weeks but what we really all need to know is what is going to happen and how it will work. It needs to work for everyone, as it is the only alternative we are being offered. Nama is a work in progress and the sooner we get the exact detail, the sooner the market will get back to some level of normality.
We understand that the long-term economic value of the asset is the price that the assets will transfer from the banks to Nama. This effectively should be the gross realisable value that comes from the asset over a reasonable period of time. It is stated that Nama is a workout agency rather than a debt collection agency and this is very important for the stability of the market.
The decision for buyers in future will be whether they buy from Nama or a non-Nama landowner. This will depend on how Nama is managed. Ultimately all parties need to approach the question on a non-political basis and focus on what is best for Ireland Inc.
In the absence of normal bank debt, funding is critical and landowners are going to have to fill the gap. In the US, there is a term called 'vendor debt' where the asset-holder provides some of the debt for the purchaser to buy his asset. I am not sure we are going to get to 'vendor debt' in Ireland for land sales, but I do believe landowners who wish to achieve disposals at realistic levels are going to have to assist the purchasers. This may take the form of the vendor providing the site to the developer at a low upfront cost and taking out the balance when the development is completed. This is not new but has not been seen for a long time in Ireland. In the 1980s, due to the high cost of funding, it was the most common method of disposal of land banks.
The current structure for the provision of social and affordable housing, commonly known as Part V, in the residential market, was required during the boom, but is now past its sell-by date. It is inevitable that it will have to be restructured or abolished. At current sales prices, most new houses are now affordable. Part V was created to provide affordable houses for essential service providers such as gardaí, nurses and so on. Ironically, they are probably the best positioned to afford houses due to their certainty of income and are best placed to benefit from the huge reductions in house prices, below affordable prices in some instances. The removal of the administration cost of Part V would also be a potential saving for local government.
There are some value buyers emerging in the market who are waiting to see the effect of Nama before purchasing. Interest rates are historically low, and as they took time to feed into the slowdown when they were high, it is inevitable that it will also take time for the impact of our current historically low interest rates to benefit the market.
There is some activity in the market, but until such time as Nama is properly established and functioning, we are not going to see any volume of transactions. However, one should be thinking forward about to how to extract value from land, and owners should take time over the next two years to add or protect value.
Land values will recover from their current perceived forced sale values to normal levels, reflecting their real economic value over the next three to five years.
James Meagher is a director of HT Meagher O'Reilly