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Rode report voices concern for property sector

MAIN IMAGE: Erwin Rode, Editor-in-chief, Rode Report

Staff Writer

The significant Rode report for the second quarter of 2022 reports on the movements of several critical property variables, ranging from capitalization rates, market rentals, operating costs, vacancies, escalation rates and land values to house prices.

The report indicates that the property sectors, like many others, are being negatively affected by increased worries about global and South African economic growth amid even higher inflation and interest rates that were expected in Rode’s Report of 2022:1. Some forecasters are even talking of a coming recession. Even the IMF has mentioned possibilities of a possible global recession in 2023 given the elevated risks.

Of all sectors, the industrial property market continues to look best placed, but it may be close to a peak given the weakening economic backdrop, which may also curb the sharp growth of logistics through weaker online sales.

The retail market made a strong recovery in 2021 and the beginning of 2022. However, the outlook for consumer spending is poor, which will hinder the recovery. The fundamentals of the office market have improved but are still poor. Flat vacancy rates and rentals have improved, but real rentals, like house prices, are still in negative territory.

Building‐cost inflation has spiked into double digits, which makes it almost impossible for rentals to grow in real terms. This significantly reduces the feasibility of building new projects, which might not be a bad thing for property fundamentals.

Office market

The office market continues to be in the worst position of the three major non‐residential property types due to its severe oversupply characterised by high vacancy rates and lower rentals. However, the results of the latest Rode survey show that vacancy rates improved slightly in the second quarter of 2022, while the decline in nominal rentals is less than seen before.

Nationally, gross market rentals for decentralized grade‐A space decreased by 1% year on year in nominal terms in the second quarter of 2022. The decline in rentals has eased gradually since the middle of 2021 when rentals fell by around 6% compared to a year earlier. This means that the worst is over as rentals are stabilising at lower levels as more workers return to offices, albeit in many instances in a hybrid way, with Covid becoming less of an issue. However, there is one caveat: the above rentals are nominal rents, meaning no rental remissions, tenant installation allowances or a number of months rent‐free are assumed. We should call these façade rentals because we do not know for sure what is happening behind this wall!

In real terms, rentals fell by more than 10% after deducting building‐cost inflation (BER BCI), which accelerated to about 13% in the second quarter, driven by double‐digit increases in the prices of steel and copper.

Regionally, Cape Town has been the best performer of late, with nominal rentals (+1,2%) rising to above those of a year ago. However, rentals for all the other major cities were either unchanged or declined compared to the second quarter of 2021, indicating that the office market is still largely feeling the pain. This implies that no major city managed to record above‐inflation rental growth.

In real terms, rentals fell by more than 10% after deducting building‐cost inflation (BER BCI), which accelerated to about 13% in the second quarter, driven by double‐digit increases in the prices of steel and copper.

Residential market

The housing market had a steady start to 2022, with nominal prices growing by about 4% year on year in the first five months, albeit marginally slower than the 4,2% growth for the full 2021, based on FNB data. However, in real terms the story does not seem so rosy, with house prices falling by about 2% so far in 2022 due to the sharp rise in the average consumer inflation rate to 5,9%. Turning to the latest monthly data, nominal prices increased by 3,7% year on year in May, slowing from 4% in April, and well below the inflation rate of 6,5% in the same month.

At this stage, the impact of interest rate hikes is not significantly slowing prices and volumes, but it will increasingly play more of a role in curbing effective demand as it increases towards its pre‐pandemic level of 10% sooner rather than later. Looking ahead, Rode expects house prices to grow at a slower rate over the next year or two due to the weak economy, characterised by high unemployment, and as interest rates rise further, thereby putting further pressure on the consumer, who is also facing high inflation. Therefore, real house price growth is still a few years away.

Turning to flats, vacancy rates in South Africa averaged 8,8% in the second quarter of 2022, down from 9,9% in the first quarter of 2022, according to Rode’s residential survey data. The improvement in vacancy rates has led to slightly better‐performing nominal rentals.

However, rentals are still declining in real terms. This means landlords are feeling the heat as total costs, including items like rates and taxes and maintenance, are rising faster than their rental income. It is significantly more expensive to maintain a home than, say, a year ago due to hefty prices of metals, such as steel. Higher interest rates of course are also lifting bond instalments.

The outlook for flat‐rental growth soon is bleak as it will be difficult for landlords to pass on sharp cost increases to tenants in the current difficult and worsening economic environment. A realistic scenario is that nominal rentals will continue to rise slowly in the next year or so, but at a rate lower than the consumer inflation rate.

Industrial market

The industrial property market continued to shine in the second quarter of 2022, with nominal rental growth for space of 500 m2 picking up to 5,4% year on year thanks to continued low vacancies. The 5,4% can be compared with growth of 0,5% in 2020 and 2,2% in 2021. However, the story is not so bright in real terms given the spike in building‐cost inflation.

This means the industrial sector is still comfortably the best placed of the major non‐residential sectors, where vacancies are much higher and above their long‐term average, especially office properties. One of the key reasons for the out-performance of industrial property is the non-speculative nature of developments. Another driver has been the superior performance of logistics due to the online sales boom, which has accelerated during the pandemic as shoppers preferred to shop online to reduce the risk of contracting the virus.

However, one must wonder whether the fundamentals in this sector are close to peaking, given the weakening economic backdrop, which will also curb the sharp growth of logistics and warehousing demand through weaker online sales.

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