I thank the committee for inviting me to attend to put in context the nature and functioning of the commercial real estate market in the period up to 2008. Members have my submission so I will not read it verbatim but will highlight some of the key points.
Commercial real estate breaks down into a lot of markets and sub-markets such as office, retail and industrial occupier markets, the investment market, the development land market and the hotel and licensed markets. All these different sub-markets operate independently of one another. Commercial real estate volumes are considerably lower than in the residential property sector but the value of commercial real estate transactions is considerably higher. In the absence of a national census or register of commercial property it is quite difficult to do as the committee asked and precisely quantify the size of the market, though some sectoral estimates on stock figures and transaction activity are collated by firms such as ourselves.
Commercial property tends to break down into three distinct elements, which are the development piece, the occupier piece and the investment piece. What happened in Ireland in the period up to 2008 is that the three distinct sectors effectively merged and real estate developers began to develop accommodation, let it out and hold onto the property for investment purposes. Invariably they then used it as collateral for other investments and developments.
Commercial property is, by its nature, a long-term investment. In general, commercial property is significantly more complex than other forms of investment and much less liquid. By virtue of the typical size of transactions it is not really a sector that is accessible to all - one needs a lot of money to be able to invest in commercial real estate. However, the emergence of the syndicate model in Ireland in the late 1990s did enable a larger cohort of investors to get into commercial property.
CBRE is a Fortune 500 and S&P 500 company with headquarters in Los Angeles. It has 52,000 employees and its Irish firm is the largest property firm in Ireland. CBRE Ireland is a multidisciplinary firm and is involved in everything to do with commercial property, be it property sales and acquisitions, leasing, investment sales, corporate services, project management, consultancy or anything else. In the same vein, we do not act for a particular type of client. We act for vendors, purchasers, landlords, tenants, developers, etc. In addition, under the property industry umbrella, we act for significant numbers of third-party providers, such as accountants, solicitors, banks, receivers and so on.
The research function at CBRE Ireland has the same platform as we have in every CBRE office across Europe, in that we have systems, databases and processes in place. Our main role is to track transactions and market information. We track transaction volume, land sales, hotel and pub sales, office and industrial leasing statistics and supply and demand to whatever degree we can. We also comment on issues such as rents, yields and capital values. All of this information is inputted into global databases and this enables us to produce pan-European publications and to compare Ireland with other jurisdictions. It is important to stress that the research function at CBRE operates independently of the rest of the business. Therefore, my team is not involved in transactional activity on a day-to-day basis. We observe what happens on the ground and we are charged with giving impartial and unbiased observations and commentary based on our interpretation of market trends from the perspective of property market specialists operating in the business.
I am not an economist. This is quite unusual because many of those on research teams working within property come from an economic background. I come from a surveying background. I am a chartered surveyor by profession and I am a full member of the Society of Chartered Surveyors Ireland, SCSI, I have completed all my postgraduate qualifications and I am a fellow of that society. Over the past 20 years, I have been a regular commentator on the commercial real estate sector in Ireland and I produce a range of publications on the market and across all of the sectors. We produce a significant number of statistical publications on the office, industrial and investment sectors, just as CBRE does worldwide. The publication we are best known for is our bimonthly report, which is more of a newsy report that provides an update or snapshot every two months in terms of trends and transactions happening on the ground.
The most significant challenge I have faced in my 20 years doing this job in trying to track the size and scale of activity is the scarcity of data. Unlike in many jurisdictions across Europe where I have colleagues working, we do not have a national property register. This has created huge issues, because it is down to private firms like ours to carry out research. Invariably, when we publish that research, it is claimed we have a vested interest. Therefore, our research has been a thankless job. I believe the Government should have established a national property register or system to enable us to track the market better. Perhaps we can discuss that later.
The understanding of risk is related to the issue of available data. Again, we do not have the luxury of a long-time series. The only independent source of data on the Irish market is produced by a private company, Investment Property Databank, IPD. I do not know whether members are familiar with the work of IPD, but since the mid-1970s, all institutionally owned properties in Ireland must value their assets quarterly. These quarterly valuations are what make up the IPD data. Therefore, the data are not representative of the entire market because the valuations relate purely to institutional assets. However, the data do give us a good barometer of trends in the market. As members can see from figure 1, the commercial real estate market in Ireland, for the period for which data are available, has demonstrated a highly cyclical pattern. This demonstrates the fact that commercial real estate is a long-term investment. According to this index, the average total return is 16.4% per annum which one would agree is a decent level of annual return. However, looking at it on an annualised basis, this is hugely cyclical. Figure 2 shows a table for the years from 2001 to 2008 where this cyclical pattern is clearly evident. In 2002, we had a total ungeared return of 2.2%. Four years later that was 24.4%.
Roughly, each cycle has tended to be of ten years duration. In the period up to 2007, considering the fact that interest rates were rising and we had built a significant amount of property in the preceding years, primarily as a result of the ready availability of cheap and plentiful debt and Government tax policy in place at the time, which incentivised real estate investment and development, it was predictable that the market would turn and we would enter the downward phase of the cycle.
If we look at what drives property, this can be broken down to four key drivers: the economic backdrop; the balance between supply and demand; funding; and sentiment. If the cycle had followed its normal or expected pattern, as we considered it would at the time, Irish commercial property values would have gradually fallen from peak levels, dipped close to or slightly into negative territory, plateaued and ultimately the cycle would have kick-started again. For the period from 1976 for which we had data, that was the pattern and what we anticipated would happen. We did not anticipate the extent of the crash that happened, and the extent to which Irish investors and developers were leveraged exacerbated their losses.
I will run through each of the four drivers individually, beginning with the economic backdrop. We are a real estate firm, not economists. Therefore, our economic projections and assumptions, both from a micro and macro level, came from outside the organisation. We would have paid huge credence to the ESRI, the ECB and the IMF. Also, as an S&P 500 company, we would have been very mindful of the ratings agencies, none of which downgraded their projections for Ireland until the third quarter of 2008.
In regard to the supply-demand balance, I know the committee had someone before it in recent weeks who said the supply-demand balance does not have a bearing. However, it is critical. Consider the double-digit house price rises we have seen in Dublin over recent times and the 50% increase in office rents in the past 18 months. This is due to the under-supply situation we are in. It was obvious to us in the period up to 2007 that an imbalance was starting to come through in supply and demand. Cheap and plentiful bank debt and Government tax policy fuelled a construction boom and encouraged the development of both residential and commercial property, much of which occurred in the wrong parts of the country. Extensive rezoning of land for development across many different local authority areas and the absence of a national planning strategy exacerbated this trend. In simple terms, we were building too much accommodation, much of which was in the wrong locations. The pace of development was unsustainable and needed to be curtailed.
As a firm, we began to warn in 2005 about the potential for oversupply and we welcomed signs that development was beginning to slow down. Against the backdrop of development continuing to slow down and domestic economic activity remaining strong, as we believed to be the case based on the commentary being provided by the IMF and the ESRI and so forth, a soft landing was plausible in our opinion. In fact, this was the most likely scenario according to a range of market advisers and participants at that time.
The third factor, one critical to the committee's deliberations, is funding. In the context of property, when we worried about funding, all we ever considered was whether interest rates were going up or down. The likelihood of a global banking crisis removing debt from the equation completely did not enter our thinking. We believed that the banks were stress-testing borrowers. A scenario where the global banking system would completely implode and where domestic debt funding would completely disappear, which exacerbated the pace and severity of collapse experienced in the Irish commercial property market, just was not envisaged.
The fourth influencer, probably the most difficult to measure, is sentiment. Herd instinct plays a part in the property market and the market is heavily influenced by sentiment. We took our role seriously and understood that commentary, positive or negative, can influence sentiment to a large degree and that this could influence activity levels and, ultimately, pricing. As an organisation, CBRE is very mindful of its role. Any commentary or observations made about the market were made objectively and without influence. Consider the client base we had and have today. Talking the market up or talking it down was not on our agenda, because we had clients on every side.
We believe our commentary always has been open, honest, based on the information available to us and based on our perspective as property specialists. From our perspective and as I stated, the information up to 2007 suggested that a soft landing was the most likely pattern. We found that a property market tends to follow the same pattern and we refer frequently to a chart, shown as figure 3 in our presentation, which comes from a book written more than 100 years ago by a man called Homer Hoyt. It follows a study of 100 years of land values in Chicago, in which eight different cycles were followed and monitored, including the gold rush, the arrival of trains and so on. Hoyt came to the conclusion that a property cycle always tends to follow the same pattern. CBRE used that graphic a lot in presentations to clients to demonstrate the cyclicality of the market and in turn, to demonstrate risk to some degree. As members can see, figure 3 typically follows the same pattern but what took everybody by surprise in the crash in 2008 is that it did not follow the normal pattern. Effectively, we jumped from stage 7, where the real estate market was peaking, to stage 12, where the banks reversed their boom policy on loans overnight. We skipped all the other stages and that led to the crash being significantly more severe. Certainly for the period for which data were available, we had never experienced anything of that magnitude.
Moving on to some of the analysis we do locally, we maintain property databases and again, these follow the same definitions and methodologies as does CBRE worldwide. We have been tracking what Irish people were spending on investment property and we track every single transaction over €1 million in value. We can then put that into a global system and look at it on a pan-European basis. According to our research, Irish investors invested more than €46.35 billion in income-producing assets with a value of more than €1 million in the period between 2001 and 2008. Were one to add properties that were below €1 million in value, that figure would probably be closer to €50 billion. I should state that more than 50% of this investment during the aforementioned period occurred in the United Kingdom and 23% in Ireland. The volume increased year on year from 2003 to 2006, peaking at more than €11 billion in 2006. Unusually, 100% of investment expenditure in Ireland in the period between 2001 and 2008 was by domestic investors. At the peak in 2006, 30% of Irish investment occurred in Ireland, with 55% in that year occurring in the United Kingdom.
To put into context how severe was the crash, at peak in 2006 there were more than 98 transactions of more than €1 million in the Irish market while two years later in 2008, there were only 26 transactions totalling less than €500 million. These data were publicly available and were produced in all CBRE research publications at the time. Anybody who went looking for it could have found it and I suppose it marries the data that were coming out in respect of the amount of lending that was going on. I have just looked at the peak of the market in the year 2006 to give members a flavour but according to this research, 36% of the investment spend in Ireland was attributable to developers, 26% to syndicates, 20% to private investors, 10% to institutions and the remainder to a combination of different investment funds, pension funds, occupiers, etc. Outside of Ireland, the proportions were quite similar. It also is important to note in respect of the types of assets people were buying that Irish investors tended to have a preference for office and retail properties.
As for development land, we also maintain a database tracking all development land in which we stripped out all agricultural sales and counted everything else. As members can see, according to that research, which is shown in figure 5, a total of almost €12.5 billion was invested in just shy of 1,000 individual development land transactions between 2001 and 2008. It is significant to point out that while much of the focus on commercial property tends to be on the land piece, four times that amount was being spent on investment property when one adds it up cumulatively. It also is important to note that while they will not be included in these numbers, members might remember that in the period between 2001 and 2008, there was a notable increase in the volume of hotel and pub sales in the Irish market, many of which effectively were land sales. One could also include petrol stations in that regard. The volume of expenditure is dramatic and increased more than ninefold between 2001 and 2006, according to our data, when more than €4 billion was invested in development land. In addition to the increases in land values in the period, there was a notable increase in transaction volumes recorded with 59 in 2001, rising to 260 individual transactions in 2006.
In both figure 4 and figure 5, I will point members to the year 2006 because that was the peak of the market based on transactional information. Towards the end of 2006 and early 2007, it was obvious that transactional activity had started to slow down. Members will have seen this in excerpts from various reports from that time. In respect of funding specifically in respect of the various transactions I have demonstrated to members on these charts, CBRE was involved in some capacity in many of these transactions, be they in Ireland or overseas. We were also involved in many of the transactions involving Irish buyers overseas and we carried out valuations for lending purposes for many of the purchasers and indeed all the Irish lending institutions. However, we were not privy to detailed information on how these specific transactions were being funded. Anecdotally, we were aware that a large proportion of transactions were debt-funded compared with other countries. We knew that from talking to colleagues in other jurisdictions. We also were aware of commentary on increases in property lending by the Irish banks and individual financial institutions. However, we were not privy to the specifics of how particular transactions were being funded, how banks were financing themselves and we certainly were not aware of the extent of cross-collateralisation that was occurring. Perhaps naïvely, we presumed that a central register of commercial lending activity tracking borrowers' exposures across different lending institutions existed. We were not aware of particular banks' exposure to specific individual borrowers. As I stated at the outset, we are not banking experts and so we had regard to assertions from the Central Bank, the Financial Regulator and others that the banks were sufficiently well capitalised and robust. We were cognisant of ratings given to Ireland by ratings agencies such as Standard & Poor's, Fitch and Moody's. Based on this, we believed that the Irish banks were well funded and appropriately regulated and that the borrowers were being sufficiently stress-tested. We had no reason to suggest otherwise and we did not have specialist training or insight or any knowledge that would have enabled us to question this.
As for lessons for the future, in the period up to 2008, to my knowledge we were not contacted by the Government, the Central Bank, the Department of Finance or the Financial Regulator at any stage for our view on property market trends from our perspective or to ask us for any of the data we were collecting on transactional activity or property market performance. In general, Government intervention in the property market was largely done without any engagement whatsoever with the property industry and certainly not with firms such as ours. In the future, we recommend engagement with such organisations that have access to reliable information on trends and transactions, as well as the ability to cross reference this with other jurisdictions and geographies because we believe this would give a valuable perspective to decision-makers and those in authority. It is encouraging that in its recent Construction 2020 report, the Government has acknowledged the need to improve data collection and analysis to ensure that the real estate sector in the future is evidence-based and underpinned by the best available data. Had reliable, honest, timely and accurate data been collected historically and reviewed in the context of a national planning framework, the scale of the downturn in the most recent cycle may have been somewhat less severe. That is my submission in which I have made every effort to address the specific items the joint committee has asked me to address. I will be happy to take any specific questions.
