Conditions in non-residential property market remain strained

23-06-2003

The non-residential property market remained under pressure in quarter 2003:1. Still, glimpses of a recovery were noticed here and there, say property economists Rode & Associates in their latest review of the property market.

In the office market, the slowdown in the declining trend of real decentralised rentals continued, says Rode’s Report editor Dirk De Vynck. This could be the first tentative sign that real decentralised office rentals may be close to their nadir.

Turning to office demand, it seems as if the strained trading conditions in the office property market have finally caught up with the Johannesburg suburbs, as office demand in these areas has now contracted for the second quarter running. However, looking further afield to the other decentralised office areas, positive office take-up was still being inferred from the Sapoa vacancy surveys. In fact, nationally the suburbs notched up net take-up of 111.000m² over the past six months.

In the CBDs, real prime office rentals in Cape Town have been flat for three quarters running, a possible indication that the city improvement district (CID) initiative is starting to have the desired effect.

The real surprise, though, comes from the Durban CBD, where real rentals have been rising for the last three quarters. In contrast, in the Johannesburg and Pretoria CBDs the slide continued.

In general, real rentals in the major industrial conurbations of South Africa are still firmly in a downswing. Still, there are some areas where a deceleration in this headlong lurch has been noted.

Of concern though, is the decrease in manufacturing production since the end of 2002. This can be attributed to a slowdown in exports, as weaker global demand and a stronger rand started taking their toll, as well as softer domestic demand brought on by a restrictive monetary policy.

Nationally, capitalization rates (non-listed property’s equivalent of the forward earnings yield on shares) are still weakening. Amazingly, however, capitalization rates for CBD offices have on average been flat for two quarters running. Still, it remains to be seen whether this is not just a flash in the pan, and whether investors truly feel that the worsening trend for the CBD office market could be over.

Capitalization rates for prime decentralised offices continued their relentless upward (weakening) march — evidence of the continued oversupply pressure felt in the office property market, which was largely the result of overbuilding coupled with incisive company rationalisations. The resultant consolidation of office space is expected to continue.

An investigation done by Rode showed that property-market hurdle and escalation rates, which remained unchanged at about 19% and 10% respectively in quarter 2003:1, are too high. The hurdle rate is the minimum total return (income yield plus expected capital appreciation) required by potential investors to induce them to invest in property. The escalation rate is the rate by which a rental is hiked once a year in terms of a lease.

“Our own investigation, using the financial market’s inferred forecast of inflation, provided powerful evidence that today’s property-market hurdle and escalation rates are unrealistically high, given the disinflation environment in SA,” says De Vynck.

In the residential market, higher mortgage interest rates continued to exert pressure on house prices in quarter 2002:3, with upper- and middle-priced suburbs, on average, showing a deceleration in real house-price growth for the second quarter in a row.

Johannesburg is the only metro area where real flat rentals were still showing strong growth in quarter 2003:1. In the other areas surveyed, real rentals were in a ‘consolidation’ phase, and “we expect that Johannesburg will follow soon,” De Vynck said.

As far as listed property is concerned, a continuation in its superior performance over directly-held property was seen, with the price premium being stretched to 17%. This implies that correctly-valued, directly-held property portfolios would show an instant capital profit if they were to be listed on the JSE.

“The climate is ripe for the huge-scale listing of directly-held property,” says De Vynck.