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Industrial, office and retail property ‘bulls’ betting on the Cape

18 April 2024 Gareth Stokes

The City of Cape Town stands out as the most positive among six major metros in a recent commercial property market survey. Unfortunately, the preference among industrial, office and retail property investors for Western Cape-based properties does little to lift the sector overall. As the second quarter of 2024 gets underway, the sector “lacks clear direction in sales activity, much like the economy that drives it”.

Commercial property perceptions in the dumps

This troubling message appeared early on in coverage of the Q1 2024 FNB Commercial Property Broker Survey which is informed by commercial property brokers in and around the Johannesburg; Ekurhuleni; Tshwane, eThekwini, Cape Town; and Nelson Mandela Bay metros. “A pre-requisite in selecting broker respondents [for this survey] is that they deal in owner-serviced properties, but a portion will also have dealings in the developer or investor markets as well as in the listed sector,” wrote John Loos, Property Strategist, FNB Commercial Property Finance, in his latest commentary. 

The survey kicks off by asking respondents for a simple “yes” or “no” response to the rather generic question of whether they find the prevailing business conditions are satisfactory. In the final quarter of 2023, around 44% of brokers responded in the affirmative; but entering 2024, this percentage has dropped to a dismal 35%. Put another way, one-in-three of the commercial brokers participating in this survey were unhappy with the economic ‘underpin’ to their businesses. 

“This decline follows on two prior quarters of [slight] improvement, reflecting a lack of any clear direction in the property market of late,” Loos wrote. “The most recent level of broker business confidence remains very weak [as] almost two thirds of respondents still perceive business conditions as unsatisfactory. This is, however, not the worse level of confidence recorded. For some context, 67% of Q1 2019 respondents were positive compared to only one-in-five at the peak of the COVID-19 pandemic midway through 2020. 

Nowadays, motivating investments in fixed assets is tough given electricity constraints, logistics hiccups and water infrastructure issues, not to mention questions over municipal finances and the ongoing decline in the level of municipal services. 

The inflation and interest rate ‘drag’

The FNB property strategist explored his survey findings in the context of South Africa’s constrained macroeconomic outlook. To begin, he noted that economy-wide business confidence as measured by the Q1 2024 RMB Bureau for Economic Research Business Confidence Index was similarly subdued, coming in at 30 on its 0-to-100 scale for the first quarter of 2024. For readers unfamiliar with this measure, a level of 50 is considered neutral; a measure below 50 reflects negative confidence and above 50, positive. 

“This lack of general confidence is very much in line with a stagnant economy moving in and out of quarterly GDP contraction recently, not only affected by significantly higher interest rates, but also by erratic electricity supply and major transport and logistics challenges in the area of rail and harbours,” Loos wrote. He confirmed the country’s “very low GDP growth rate” of only 0.6% for 2023 as a whole. That performance, dear reader, points to an economy beset by structural challenges. 

Inflation and interest rates are important to property investors and speculators too. Why? Well, if you are borrowing funds to purchase a commercial property, any rate hike pushes your monthly repayments higher. And if you are investing in property to generate a return for yourself or your clients, then each rate hike changes the risk free rate of return that you can ‘bank’ from the bond and money market. Remember, property investors have endured a 475 basis points in rate hikes between November 2021 and May 2023. 

CPI is going in the wrong direction, again

Loos had hoped that unchanged interest rate environment since May 2023 would lift property investor confidence; but this hope proved premature. In any event, the South African Reserve Bank (SARB) has yet to give any additional stimulus in the form of interest rate cuts. “It remains cautious on interest rates as inflation is too close to the upper limit of its 3-6% target range,” he said. And all hopes of an early rate cut were dashed when the country’s February 2024 inflation print confirmed a slight acceleration in consumer price inflation, to 5.6% compared to January’s 5.3%. 

The 29 May 2024 National Elections, which many expect could usher in an era of uncertain coalition politics at provincial and national level, are adding to uncertainties over the future direction of interest rates, and the outlook for commercial property. “There may be something of a wait-and-see approach by some [property] investors at least until after the May election,” Loos said, before returning to the main findings of the Commercial Property Broker Survey. 

Respondents were asked to rate their perception of buying and selling activity levels in their respective markets from one-to-10, with 10 being the strongest rating. It turns out that respondents’ average ratings were lower in two of the three major property classes. Brokers were most optimistic about industrial and warehouse properties, though their activity rating strengthened only slightly from 5.44 in Q4 2023 to 5.59 in Q1 2024. The retail property activity rating declined from 4.9 to 4.36 over the same period while the office property activity rating fell from 4.29 to 3.72. 

Higher levels of investor confidence

“Cape Town remains perceived as the strongest market sales activity-wise while Gauteng’s metros are at the weak end of the spectrum,” Loos said. After adjusting for volatility due to the small survey size, Loos noted that average sales activity ratings were highest in the City of Cape Town across all three major commercial property markets. 

“The outperformance of the City of Cape Town has been in play for a while, with the Western Cape region benefiting from higher levels of investor confidence due to a widespread perception that its provincial, and many of its local governments, are better functioning than many other parts of the country,” Loos wrote. No surprises there, dear reader. 

The Greater Johannesburg region is bearing the brunt of this shift, with the lowest retail activity and office activity ratings for the quarter. The City of Tshwane did not perform much better, with weak activity ratings across the board. You can even find recent migration data published by Statistics SA to support that all-and-sundry are declaring Cape Town as the better place to be. The publication revealed that 35% of returning emigrants favoured the Western Cape in 2022, compared to 23% in 2011. 

Hamstrung by lacklustre economic growth

“The combined results regarding broker business confidence as well as broker sales activity perceptions show a lack of any strong direction [in the commercial property market], but on balance hint at a slightly weaker market early in 2024,” said Loos. “Satisfaction with business conditions weakened quarter-on-quarter, and remains at a very weak level, not far out of kilter with weak broader economy-wide business confidence”. He said he was not surprised by the survey result given South Africa’s lacklustre economic growth performance and outlook. 

As for a turnaround, Loos concluded that commercial property investors may have to wait until the second half of 2024 for more convincing signs of sales activity strengthening. FNB expects the SARB to commence with mild interest rate cutting shortly after mid-year, by which time the elections will have come and gone. 

Writer’s thoughts:

Back in the days, many high net worth (HNW) individuals went ‘all in’ on commercial property, backing this fixed asset class for its income and capital gains prospects. Is this still the case? Do your clients still approach you for advice on entering or exiting commercial property portfolios? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.

Comments

Added by Gareth, 18 Apr 2024
Thanks for the detailed response, @Michael. Your point re brokers 'talking their book' is certainly worth exploring - I guess they have to stay positive, given commercial property is their livelihood. 1000 percent agree with your comment re GDP growth and government's role in eroding same.
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Added by Michael, 18 Apr 2024
Property is dead, long live property? The entire property question is a vexing one and one which is not easily answered. Commercial property at one stage was a no brainer, an absolute no brainer. The economic and political sentiment in RSA at the moment on a micro ( inside South Africa) differs from region to region, in the Western Cape the property bulls are running, however in my opinion, this is more the property brokers (who cannot get the same sales/ returns in Johannesburg/Tshwan) talking their books. On a Macro RSA view, the economy is tanking, the political future is uncertain, emotional decisions are being made on whom you think will be the ANC alliance partner and the implications thereof, the expropriation without compensation ( where will that end), the death by a thousand cuts ( increasing municipal taxing (rates increasing), providing electricity and water ( where local government is failing), all of which requires huge capex investment, this is funded by investors, shareholders or financial institutions which come at a cost to the property owner. My current advice to clients is to avoid commercial property unless they find a perceived bargain in a stable location and the yield makes the risk worthwhile. My views may be contrary to the " collective wisdom" out there but I honestly think that challenging times lie ahead. The only solution to RSA challenges is a growing economy which is allowed to grow unfettered by Government interference and red tape and a government which reigns in corruption and maladministration and yes an interest reduction and a big one at that.
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