The building blocks of recovery

This week served up no shortage of reminders of the turn in fortunes for the real estate sector in Ireland. Rents continue to pick up, which is supportive of the outlook for prices in the main urban centres here.

The two Irish listed REITs will be in for some new competition with Kennedy Wilson Europe confirming its IPO intentions today, but with plenty of assets earmarked for sale by the banks and NAMA this shouldn’t unduly impact their acquisition plans. Next week is reasonably quiet in terms of scheduled data releases, with Thursday’s CPI release expected to show that price pressures remained muted into the New Year.

Key stories from the past week 

Limited read-through from KBC and Lloyds’ results 

Two of the overseas institutions with a presence in the Irish market reported numbers this week. KBC’s Q4 results had few surprises, with impairment charges in line with guidance and its longer-term profit targets reaffirmed. We are encouraged (but not surprised) to see a discernible slowdown in mortgage arrears formation. Elsewhere, Lloyds’ 2013 results showed a precipitous drop in impairment charges (down 51% to £608m) while its Irish book, all of which is in run down, reduced from £19.5bn to £15.4bn. Lloyds struck a surprisingly negative tone in terms of its outlook for the Irish real estate market – as this is at odds with IPD and CSO data that show a pick-up in real estate prices, we suspect that its views may be clouded by the nature of its own exposures here. Overall, the read-through for the wider Irish financials space from the above is limited.

Real Estate Investment: Green REIT interims show progress; Hibernia confirms plans; KWE to IPO 

GRN’s interim results showed that the group has agreed to invest €214m, or 70% of the net proceeds of its IPO, to date. The blended yield on its portfolio stands at a healthy 8.7%. There were few surprises in this update, which show that it continues to amass a portfolio of high quality properties in attractive locations. Elsewhere, Kennedy Wilson Europe confirmed that it is to IPO. It will use the proceeds to buy real estate and real estate loans in Ireland, the UK and Spain. Finally, Hibernia REIT’s IMS saw it reiterate plans to “build a portfolio of attractively located, institutional quality, primarily income-producing properties, mainly in the Greater Dublin area”.

Construction activity rises again in January 

The Ulster Bank Construction PMI came in at 56.4 in January. While below December’s 58.3 reading, it is nonetheless consistent with a robust rate of growth. A fifth successive above-50 PMI reading shows that the recovery in the construction sector is gathering momentum, but within that civil engineering continues to lag housing and commercial activity.

Dublin rents continue to surge 

The latest rental report from the country’s biggest property website, Daft.ie, shows that rents in Dublin rose at 11.2% y/y in Q4 2013, the fastest pace of growth since mid-2007. Rents in the capital are now 18% above the low-point seen in mid-2011 and 15% below the mid-2007 peak. In the rest of the country, however, the picture is somewhat different, with growth of 2.8% y/y seen outside of the capital in Q4. In the other four cities (Cork, Limerick, Galway and Waterford) and Leinster (here defined as the East of the country, minus the Dublin market), rents rose by 4-5% during 2013 while rents in other areas did not increase during 2013. The pick-up in rents across the country’s main urban centres is supportive in terms of the outlook for prices in those markets.

Trade Idea of the Week: Buy IRISH 3.4 03/24; Reiterate long on AIB 2.875 11/16 

This week saw the NTMA reiterate previous guidance that it will “look at the possibility of offering investors the opportunity of switching some of their holdings of the 4.60% Treasury Bond of April 2016 into longer dated bond(s)”. The relevant bond accounts for 9% of the stock of Irish government bonds in issue (the third largest amount outstanding).

Demolishing this funding cliff has clear attractions for the NTMA, which has sufficient cash resources at hand to cover funding needs into 2015. Where might it target as a destination for switchers from the 2016 bond? It is possible that, as with the last switch in 2012, it may offer a new bond. On this, we note that the absence of any maturities in 2021 and 2022 makes this an area that the agency could target. However, looking a little further out the curve, taps of either (or both) of the 2023 and 2024 bonds cannot be ruled out given the modest amount outstanding of both issues.

We do not see bonds with a maturity date before 2021 being offered as part of a switch, given that 58% of the current stock of Irish bonds in issue are already slated to fall due before the end of this decade.

So, with the 7-10 year space looking ripe for the NTMA to target with a switch, we think there is scope for that part of the IRISH curve to benefit from index extension once the transaction occurs. Of the two bonds in issue with that tenor, the IRISH 3.4 03/24 looks the more attractive to investors. It currently yields 3.27% (MS+134bps), offering 27bps pick-up over the IRISH 3.9 03/23. We have long argued that Ireland is transitioning from being one of the PIIGS to a new ‘semi core’ status. For those who share our view on that, the pick-up over the BGB 2.6 06/24 has widened to 83bps currently from the 71bps seen in the wake of the Moody’s upgrade in January. So, whether viewed as a punt on index extension, a ‘semi core’ convergence trade or on a standalone basis, we think the IRISH 03/24 is one to buy.

Separately, we continue to like the AIB 2.875 11/16 senior unsecured bond. It has tightened again to MS+184bps from last week’s MS+195bps. While the pick-up over the BKIR 2.75 06/16 is now at a record low of 44bps (it was 59bps in late January), we view this as generous compensation for only an extra 5 months of curve. Stay long.

Provided by:

Philip O’Sullivan | philip.osullivan@investec.ie | +353 1 421 0496