Commercial property in the doldrums, awaiting economic tailwinds

Will the pandemic and subsequent national lockdown lay waste to sub-sectors of South Africa’s property market? Our gut feeling is that the forecast surge in business liquidations and the implementation of countless business rescue processes will ripple through the commercial property sector, while the three million expected job losses will shatter prospects in the residential market. Time will provide a clearer picture; but over the short term we expect small, undiversified property investors to suffer a severe contraction in both rental income and balance sheet valuations.

Selling under financial duress

The opening observation in the Q3 2020 FNB Commercial Property Broker Survey is ominous. It singles out “financial pressure” as a key motivator for sales in the so-called owner-serviced commercial property sector. The survey reflects the perceptions of commercial property brokers in six of South Africa’s largest metros, including City of Joburg; Ekurhuleni; Tshwane, Ethekwini; City of Cape Town; and Nelson Mandela Bay. 

“Financial pressure is by far the biggest single driver [of decisions to sell commercial property in this segment],” writes John Loos, Property Strategist at FNB Commercial Property Finance. He adds that owner occupiers are perceived to be selling or relocating due to financial constraints (57%); followed by relocating to be closer to the business’ particular market (27%); and looking for a location with better access to transport, logistics and commuter nodes (21%). 

Future iterations of this survey will make for interesting reading, as the full impact of COVID-19 on commercial property owners becomes apparent. These metrics will come under pressure as businesses dispose of various property assets through liquidation or restructure and will be further affected by significant changes in the usage, by extent and nature, of commercial properties. Reasons such as ‘relocation to bigger and better premises’, already at a rather subdued 9%, will fall further as economic realities ‘bite’ and the trend towards work-from-home gains momentum. 

Landlords should be getting uneasy

Asset managers who rent commercial properties to generate income are struggling too. “The noticeably elevated percentage for downscaling due to financial pressure, along with the lower percentages of selling in order to upgrade, during the second and third ‘lockdown’ quarters compared to the pre-lockdown quarters, ties in with data regarding rental payment performance in the tenanted market,” writes Loos. There was a significant drop in the percentage of commercial tenants in good standing with their landlords, insofar rental payments, through the first half of 2020. This measure had fallen from 73% of tenants being in good standing at end-March 2020 to just 48% by end-May. And the July number has only recovered slightly, to 52%. 

Those with large portfolios spanning the industrial, office and retail sectors of the domestic economy will be watching key indicators in each of these sectors. They will, for example, focus on the sectors exposed under their industrial book, the quality of their office tenants and the location and size of their retail properties, among other factors. Those with a retail focus would do well to consider recent observations from Lightstone, a leader in property-related data analytics. 

“The retail industry needs to rethink the way they operate”, said Roger Blewett, Geospatial Solutions Consultant for Lightstone. “The current environment offers retailers an extraordinary opportunity to think about omni-channel strategies, which marries the digital with the bricks and mortar retail space, that remains simple and convenient”. In other words: Retailers must ensure that their retail assets are ‘fit for purpose’ to deliver on consumer needs, which include convenience and simplicity driven by technology. “Retail decisionmakers need to understand the external environment from an economic perspective, as well as an internal environment where cultural and consumer behaviour becomes key,” he said. 

Predicting the unpredictable

What happens next is anyone’s guess. But those who believe that normalcy will return as the pandemic passes could be in for a rude awakening. “The economy was already on a path of long-term stagnation prior to COVID-19,” writes Loos. “And the financial pressure-related statistics [discussed today] were already weak before the ‘lockdown’ quarters”. The FNB property market commentator is equally dismissive about positive spin-offs from lower interest rates. In a note issued following the recent South African Reserve Bank (SARB) MPC committee decision to leave rates unchanged, he observes that commercial property is less sensitive to interest rate moves than the residential market. 

“The Bank has given significant stimulus this year, cutting interest rates by 3%”, he said. “This appears to have breathed significant life into the residential demand side of the property market; but the commercial property market is more subdued and not taking the low interest rate bait”. He concluded that the trend of selling due to financial pressure would continue post-lockdown as commercial property owners downscale to ensure the longer-term sustainability of their businesses. The FNB view, based on their Commercial Property Broker Survey and the latest available TNS rental statistics, is that the full post-lockdown economic recovery will be slow. 

Writer’s thoughts:
We have heard of many entrepreneurs who have invested in their business premises and portfolios of residential properties to provide capital and income through retirement. Few of them would have foreseen the impact that COVID-19 could have on their plans. Would you agree that the current outlook for commercial and residential rents and property valuations teaches valuable lessons about the importance of asset class diversification? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.