Eight themes for commercial property gurus to chew on
The two-year-long COVID-19 pandemic and ongoing post-pandemic economic fallout has dampened prospects for direct investments in commercial property, with institutional investors such as insurers and retirement funds thinking twice before ploughing into multi-million-rand office parks or shopping malls. In fact, this writer has heard suggestions that retirement fund trustees and their investment advisers should put these types of opportunities near the bottom of their ‘infrastructure investments to consider for the decade starting 2023’ list. But enough of this conjecture.
Substituting conjecture for an expert view
To find out what is happening in South Africa’s commercial property sector requires a market commentator with unquestionable credentials and decades of experience in the field. Enter John Loos, Property Strategist at FNB Commercial Property, who recently shared a paper describing eight key themes to look out for in the domestic commercial property market in 2023. “With the expectation of a renewed economic weakening on the back of a global economic slowdown; recently rising interest rates; and major electricity supply problems, a broadly weaker property market in 2023 is anticipated,” Loos wrote, using the opening paragraphs of his report to dash hopes of stellar short-term returns from this asset class.
Loos wasted little time in commenting on the interest rate environment either, saying that although the South African Reserve Bank (SARB) was probably nearing the top of the current interest rate hiking cycle, the full impact of rate hikes has yet to be felt. South Africa has endured eight rate hikes since November 2021, taking the Repo rate from 3.5% to 7.25%. “Overall, the industrial property market is expected to remain the relative outperformer albeit with a slower year in that property class … while the recently strengthening residential rental market may ‘level out’, with 2023 expected to be slower for residential development too,” he wrote. Over the following paragraphs we will touch on each of the eight aforementioned themes, with thanks, as always to Loos and his team at FNB for the detailed analysis.
Interest rates, vacancies and value decline
The first theme to look out for, is a renewed rise in the All-Property Vacancy Rate. “A renewed increase in economic pressure may once again place additional constraints on commercial space demand in 2023, in turn causing the national vacancy rate to resume the earlier rising trend this year,” said Loos. Of course, a rising vacancy trend is bad for commercial property owners… Readers will be familiar with most of the economic bad news, but we can restate the Eskom loadshedding crisis; ongoing political uncertainty; and rampant criminality as the main constraints on the country’s short-term growth outlook. As an aside, FNB has a rather optimistic 1.2% pencilled in for GDP growth in 2023 compared to many analysts’ forecasts that are nearer zero. In fact, just days after this publication, the SARB downgraded their growth forecast to 0.3% for this year.
The second and third themes are more technical in nature. For the second theme, Loos contends that weaker property income prospects may exert further pressure on capitalisation rates, despite the easing effect that would accompany the end of interest rate hikes. In other words, the long-term pressure on capitalisation rates is likely to remain in place. “Financial pressure on South Africa’s commercial tenant population is expected to increase, driven by slower economic growth this year, and a higher average interest rate on debt compared to 2022,” he writes. “In addition, operating cost inflation faces upward pressure from the next severe electricity tariff hike recently approved, while many businesses may have to incur further costs to ensure a reliable electricity supply in the face of recent further deterioration in Eskom supply reliability”. Theme three, is that the average capital value per square metre of commercial property will enter real decline. That, dear reader, means that the value of property investments will grow slower than inflation, eroding the value of your clients’ investments over time.
Property punters have nowhere to hide…
The fourth theme is a bit of a catch-all for every segment of the commercial property market, which Loos summarised as all three major commercial property markets to trend weaker in 2023. He reckons that the industrial, office and retail classes will feel the ‘pinch’ this year, with the office property class likely to lag the industrial and retail classes by some way. “The office property class [already at a high national vacancy rate of 18.5%] is expected to see its national average vacancy rate continue to rise in 2023, with little to drive any significant growth in demand for space in the near term,” Loos wrote. He added that weak economic growth and smart utilisation of office space were additional demand side constraints. No surprises here… And yet, each time we drive through a major city centre we see plenty of new office stock under construction.
Under theme five, Loos observed that the residential rental market may be peaking this year. Those looking for someone or something to blame need look no further than interest rates. “While rising interest rates can initially strengthen a rental market, as aspirant home buyers delay purchases and rent for longer, ultimately the rising interest rates and a slowing economy can begin to exert financial pressure on rental tenants,” he said. Any of your clients that rely on residential rentals for income may, therefore, have to tighten their belts for a while as the post-lockdown recovery loses steam. Sticking with the residential property class, theme six is that the residential development market will have a slower 2023 too. To support this observation, Loos wrote: “residential building plans passed, a lead indicator of building activity to come, saw a 6.4% year-on-year decline in the third quarter of 2022, after a bout of solid positive growth in prior quarters”.
Western Cape good; everything Eskom bad…
Theme seven is hardly surprising either, being that the Western Cape Region will outperform, thanks to the (s)emigration effect. Ask any Gauteng ‘remainder’ and they will share a story about a close friend who made a mint on a Durbanville or Bellville property after semi-grating three or four years ago… On a more serious note, Loos observed that the Western Cape has a superior ability to attract the skills and purchasing power that are essential for growth. “The province has been the most popular net middle-to-higher income group destination for many years now, due to the perception of the province as having a great lifestyle coupled to significant economic opportunity,” he wrote. This trend should exert upward pressure on prices in all property sectors.
Last, but not least, the eighth leg of Loos’ property theme ‘spider’ is that electricity will be a key property market driver through 2023. Just imagine the extra zero your client could add to the asking price for a unicorn property that lies in a ‘no loadshedding’ zone. “Electricity availability and cost will be a major property market theme in 2023,” concluded Loos. “The recently heightened state of load shedding by Eskom has an indirect impact on the property market’s performance via its negative impact on economic growth and resultant lower demand for commercial space; but there is also a direct operating cost impact on property owners and tenants”.
Writer’s thoughts:
It seems like commercial property investments are a bit of a coin toss these days. Some investors cannot stop talking up the merits of the asset class, while others end up stuck in an underwater investment that they simply cannot unload. Do you still consider commercial property investments for your high net worth clients, or are there better risk-return prospects elsewhere? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
