Directly-held property is finally on the move

22-12-2003

It’s been a while since the non-residential property industry has had a Christmas gift. Now, after years of unfavourably high capitalization rates, it seems that the worst is finally over for investors.

Property economists Rode & Associates’ overview of the property market shows that capitalization rates for all non-residential property types, except industrial, declined (strengthened) in quarter 2003:3. This was fuelled by listed property funds’ insatiable demand for non-residential directly-held property. Capitalization rates are the non-listed equivalent of the forward earnings yield of shares and hence declining capitalization rates are the result of rising prices.

Rode’s Report editor Dirk De Vynck says word in the market is that because of listed property’s premium trading position relative to directly-held property, listed property funds can afford to pay more for good-grade unlisted non-residential property and still realize a profit on listing. “Even positive gearing is now possible on buying properties for a listed fund. Hence the decline in capitalization rates.”

Rode’s latest analysis of capitalization rates relative to property unit trust (PUT) yields shows that listed property held on to its premium trading position relative to directly-held property in quarter 2003:3. But the value gap is narrowing, and this time round it is not because of a positive rerating of listed property — as had been the case since the beginning of 2002 — but rather because of the rerating of directly-held property.

Further good news for the industry is that all the signs for an imminent upswing in real decentralized office rentals are here. De Vynck says office take-up gained further momentum in quarter 2003:3, slowly mopping up the oversupply brought on by over-eager building following the high real rentals of the late 1990s. And capitalization rates, which reflect investors’ income expectations, are coming down (strengthening).

The first fruits of this improvement were already evident in the decentralized office markets of Pretoria and Durban, with higher real rentals achieved in quarter 2003:3. However, in Johannesburg’s north and in the suburbs of Cape Town, the pressure from the oversupply of space was still being reflected in real rentals.

Notwithstanding the positive office take-up noticed in most of the country’s CBD office markets, real rentals continued on their secular (long-lasting) downward trend.

Rode’s analysis of industrial rentals for quarter 2003:3 shows an uptick in the real rentals for the Cape Peninsula and Port Elizabeth, whilst on the Central Witwatersrand the movement was sideways. Although it would be premature to call this the first signs of a turnaround, there are indications that the local industrial market is slowly starting to lift its head. Recent months have been characterised by a substantial lowering in interest rates, which should further boost consumer spending, which of course underpins the manufacturing, storage and distribution sectors. This is a key development, because demand for manufactured goods is an important proxy for the demand for industrial space.

In the residential property market, nominal house prices were still on the up, albeit at a slower rate than the feeding frenzy seen since 1999. A possible reason for the slowdown could be the lagged effect of the steep rise in the prime interest rate from 14% in February 2002 to 17% in September the same year. Nevertheless, on average the price of a house was still growing in excess of 10% p.a.

The exception, however, is the lower-priced suburbs, which have shown accelerated nominal annual growth for the year ended quarter 2003:1. In hindsight, it was only a question of time before prospective buyers caught on to the relatively better value of houses in the lower-priced suburbs. Furthermore, the accelerated performance could also have been fuelled by the growing investor interest in the buy-to-let market. This can be explained by the fact that investors can enter the market in lower-priced suburbs at a higher income yield than in the higher-priced suburbs.

As for the flat-rental market, the upswing continued. On average, real flat rentals in the major metropolitan areas continued their good run of recent quarters. “The odd one out is the Johannesburg flat market, where real rentals are still backtracking. However, in the light of the real increases noted elsewhere, we expect Johannesburg real flat rentals to follow suit soon,” De Vynck says.

“Still, the increase in real rentals does seem somewhat odd, especially since the market for rental accommodation has been flooded with new townhouses to satisfy investors’ appetite in the buy-to–let market.”

Further high season cheer comes from indications that conditions in the building-construction industry have finally also become upbeat. Although the growth spurt in residential building activity has slowed down somewhat over the last few months, activity in this sector is expected to remain strong, benefiting from the string of interest rate declines over the last few months. Despite this, it is highly unlikely that home-builders’ profit margins will continue growing at their present sky-scraping rates.

In the non-residential building-construction sector, the future also seems more positive, with indications that the lacklustre building activity of the last year or so may be over.