SA Commercial Industrial Property Market Still Strong

Still Booming Says Rode

An article released by the South African Insurance Times and Investment News website argues that despite the prevalent doom and gloom currently being experienced in the residential property market, commercial and industrial markets are still booming. This is according to the latest issue of Rode’s Report on the South African Property Market.

As Erwin Rode says, “Industrial rentals in particular are sustaining the robust growth we saw during the first quarter of 2008. For example, nominal rentals for prime industrial space in the Central Witwatersrand have shown a particularly impressive year-on-year growth of 27%”.

The report indicates that other industrial nodes that have performed well include the Cape Peninsula with a growth of 24%, Durban at a growth of 22% and Port Elizabeth growing by 14%.

According to Rode, “This is particularly impressive when one takes into account building-cost inflation: even though this is expected to have grown by 20% on a year ago, we nevertheless still saw real-rental growth in all of these industrial areas, barring Port Elizabeth”.

Although the building industry was expected to reflect a slowdown, the latest Rode’s Report shows that non-residential building activity (represented by real gross fixed capital formation or GFCF) was up by 14% in the last quarter of 2007, while residential GFCF, which has actually been slowing since the end of 2005, grew by 6.4%.

However, Rode concedes that it still remains to be seen what effect Eskom and its moratorium on new developments could have on the industry. The report shows that office rentals in certain areas have done quite well too, with rentals in Johannesburg up by 16% and in Pretoria and Cape Town, decentralized figures up by 15%. Taking into account building-cost inflation of 20%, it is unlikely that these decentralized office nodes will reflect positive real growth over the last year.

Flat rentals in Johannesburg were also doing well, with nominal rentals ending on an average 26% higher year-on-year, which far exceeds the growth rate in consumer inflation of 9%. However, other metros did not fare so well, with the lowest being achieved in Cape Town and Pretoria at only 8%.

When it comes to the listed property sector, the report shows that investors are now insisting on higher income returns, which has in turn led to price drops in the market. Since the end of 2007, the historic income yields on listed property have weakened (increased) from about 6% to over 8% during May this year, resulting in an average price growth of –6% year-on-year during the first quarter of 2008.

With regard to capitalization (‘cap’) rates for prime office property, the report also indicates that this sector of the market is still reflecting some strength in the first quarter of 2008, although the cap rates on industrial leasebacks and shopping centres have weakened.

Rode says, “The non-residential market has been a sellers’ market since 2003, but under the current circumstances, it could now turn to being a buyers’ one. However, the prospects of strong rental growth could still provide a negotiating lifeline for sellers”.

Where property investors are concerned, the report indicates that a total return (income return plus capital appreciation) of around 15-15.5% was expected during the first quarter of 2008. “One of the ways of determining the value of an income-producing property is by discounting the expected future income stream by a required hurdle (opportunity-cost) rate,” Rode explains.

Essentially, the sharp decrease (or strengthening) in hurdle rates since 2000 acts as an indication of how favourable investor sentiment has been towards non-residential properties. Rode goes on to say that this was not just a result of the strong business-cycle upswing in the South African economy at the time, but also the structurally low, stable inflation and interest rates, which promised lower, risk-free opportunity costs.

However, in the current economic environment, investors may soon require higher minimum income and total returns in order to convince them to acquire directly held property. There is also little relief expected for the housing market – in May this year, national house prices in the middle segment of the market showed a growth of only 4% year-on-year. Even more concerning is the fact that house prices were 0.1% lower in May 2008 than they were a month earlier.

According to John Lottering, an economist at Rode & Associates, “We have year to see the impact of the interest-rate hikes experienced not only in April of this year, but those as far back as October and December 2007, as the full impact of these hikes is only truly revealed in the market up to three quarters of a year beyond their occurrence. We are of the opinion that by the end of this year, average prices could contract by up to 10% compared to December 2007”.

The information in this article is courtesy of Lynette Smit (“Rode’s Report on the SA Property Market 2008:2”, ITInews, 17 July 2008).

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