An Industry Check-Up
Vacancy rates – climbing?
Norman Raad, CEO of Broll Auctions and Sales, believes that the commercial property market was overvalued. “Vacancies have increased across the board and the property sector was already struggling as businesses started to consider consolidation, or were looking for smaller, cost-effective premises.
Since the (COVID-19) pandemic, some businesses have not reopened, making it difficult to calculate increases in vacancies. “The pandemic has brought forward the correction to an overvalued commercial sector, I believe. The disparity between new developments and existing properties has increased drastically, slowing the demand for new developments. Commercial offices were already experiencing massive reversions and increased vacancies before the pandemic. The pandemic has just exacerbated it,” says Raad.John Loos, an economist for Commercial Property Finance at FNB agrees that it is too early to calculate vacancy rates: “We don’t have data released that can show the extent of the impact of recent lockdowns, and the massive likely drop in GDP in the second quarter, on the commercial property sector.”
Loos expects vacancy rates to reach double-digits this year, on the back of a sharp GDP contraction forecast of 8 per cent for 2020 as a whole. “In addition, the MSCI All Property Vacancy Rate recorded 6.7 per cent last year and rose in 2018 and 2019 due to the multi-year economic growth stagnation.”
Estienne de Klerk, the CEO of Growthpoint, one of South Africa’s largest real estate investment trusts (REITs), adds that the country entered the COVID-19 pandemic with a surplus of commercial property space in the market.
However, he sees a possible silver lining to the clouds for a sector that he believes has come through the initial shock of COVID-19 in a structurally sound manner for its entire value chain, playing a pivotal role in supporting vulnerable small businesses and protecting jobs.
Will the working from home lockdown phenomenon affect occupancies on an ongoing basis, creating further vacancies?
Despite its initial appeal, Rob Kane, the CEO of Boxwood Property Fund believes that the novelty of working from home is wearing off. “City centres have been around for many thousands of years and it is unlikely that the pandemic will destroy peoples’ need to congregate to do business. We estimate that by year end, people will have learned to live with the presence of COVID-19 and business will continue,” he adds.
Rental growth pressures
Loos believes there is a sure recipe for full-blown rental value decline. “Rode’s national prime industrial rental inflation y/y was at +0.7 per cent, by the second quarter, while national decentralised A-grade office rentals were already in slight deflation of -0.7 per cent. These saw significant declines in prior quarters. Therefore I expect it is realistic that both, along with retail rentals, will be more significantly negative from H2 2020 into 2021,” he adds.
Notwithstanding the “now”, De Klerk however believes that property has always been a long-term investment: “Rental growth has been inhibited recently because other costs that make up a business’s total cost of occupancy have been subject to hefty increases, including electricity and the alarmingly high rates and taxes increases.
“Our tenants must reduce these costs in order to sustain their businesses. Bringing down operational costs is an ongoing focus area for Growthpoint. We have been investing in solar power and other technology to offer a lower cost of occupancy, while also supporting business continuity with back-up power and water.”
Kane adds that those buildings that offer value for money, regardless of their grading, will retain their tenants.
“This massive hit has been difficult for even the most astute property developer or landlord. The lacklustre economy simply doesn’t support any sort of annual escalation. This won’t be good for property owners, who rely on the compounded escalations to repay their investments over a period, and understanding what lies ahead fears most investors and business owners the most,” Raad warns.
Depreciation in capital
De Klerk is bullish about the industrial sector: “Industrial property, and more specifically warehouse/logistics, proved to be the most resilient of the sectors pre-pandemic. The property sector is entrepreneurial, making it naturally agile and positioning it well for a recovery when economic conditions improve.
“Our office portfolio has been its best performer since the lockdown in March due to supportive blue-chip clients.”
Raad feels that property will always be a sector to invest in. “There could be an increase in direct investment as interest rates are at an unprecedented low. Returns, if backed by a solid tenant, could be financially attractive over the next few years.”
“When one looks at the quality of some of the funds and their forward yields, there is definitely value to be had for investors,” agrees Kane.
What is the market outlook?
As an economist, Loos expects the best part of a 15-20 per cent decline in average capital value of all commercial property through this year and next year, adding that full price corrections lag an economic shock due to market resistance to drop values.
Pessimistically, he predicts: “Towards 2022/23, I expect the real value gradual decline to resume, meaning low-value growth not keeping pace with general economic inflation, as the economy returns to its long-term stagnant ways, constrained by many structural problems.”
Raad agrees, adding that there is no short-term solution. “The country as a whole would need to turn this tanker around, which is very close to hitting an iceberg.”
“Our biggest threat is corruption and at the expense of repeating many people, the president needs to stop talking and actually put some people behind bars,” suggests Kane.
Kane says that positive meetings have been held between Cape Town City, Wesgro, Provincial Government and Metro Police to discuss how to stimulate recovery together in the City of Cape Town CBD.
“Shortly we will host a business think tank to find practical, immediate and longer-term solutions. You may recall how quickly things were done prior to the World Cup 2010,” reasons Kane.
Targeted fiscal stimulus
“Start with a reduction in rates. Commercial tenants are usually responsible for the rates and utilities and these have increased, increasing the burden on business. Electricity needs to be reliable and affordable. It has increased over the years to unaffordable levels, without consistency of supply. Investment into small businesses through these concessions is the easiest way to create stimulus,” suggests Raad.
De Klerk comments that, while the South African REIT Association has approached the Treasury for some regulatory relief to enable members to retain earnings without losing their status, to date the National Treasury and the municipalities have not financially assisted the property sector directly.
However, adds Kane: “National, provincial and local governments can all do a lot to remove red tape and stimulate business. The actions needed are not difficult – just ask any competent business person – they will tell you.”
“Short-term fiscal stimulus measures have been massive, and interest rate cuts have been aggressive. But the only real solution to SA’s long-term growth stagnation is those well-documented structural reforms that are desperately needed,” concludes Loos.