Don’t write off listed property yet

29-06-2006

Listed-property investors should not be too perturbed about the recent correction in share prices, as strong income-stream growth is likely to compensate them during the next few years as the upswing phase of the non–residential property cycle progresses. This is according to the latest Rode’s Report on the property market compiled by Rode & Associates property valuers and economists.

In support of this contention, the report points out that in the first quarter of this year, vacancies in most office nodes had declined to close to ‘natural’ levels. Despite this, office rentals in decentralized office nodes were only 7% higher than they were a year earlier − that is, less than half the growth in building costs. However, coming off a lower base, CBD office rentals grew by 16%, which is slightly higher than building-cost inflation.

Capitalization rates of office, industrial and shopping centres continued their trend since 2003 on the back of lower interest and inflation rates, and declined further during the first quarter of 2006. Capitalization rates — the non-listed property sector’s equivalent of the forward earnings yield of shares — decline when prices rise. The concomitant decline in listed property yields that resulted from the lower interest rates has made it possible for listed funds to be more aggressive buyers, says CEO Erwin Rode.

“Unlike interest rates that currently have an upward bias, we suspect that capitalization rates still do not fully reflect long-term inflation expectations. Our take is that they will continue to decline.”
Rode also cites anticipation of the upswing phase of the long property cycle as a force that is likely to drive a further decline in capitalization rates.

Although manufacturing production again took a slight dip in the early months of this year, it was still up on the same period a year earlier. Of course, the manufacturers of export goods continued to be flogged by a strong rand, but strong local demand continued to support this sector. In the coming months, sound macroeconomic fundamentals are likely to keep consumer confidence high, in spite of rising interest rates, which should keep domestic demand robust and, in turn, keep demand-side pressure on industrial rentals.

“A gradually weakening rand will also hopefully take some pressure off the manufacturers of export goods. Notwithstanding this, the big driver of rentals in the coming year will be building costs.”

After several bumper years, the building contractors’ bonanza continued as construction prices during the first quarter of this year (as measured by the BER Building Cost Index) were up by about 16% on the same period last year. During the reporting quarter, building-input-cost inflation (as measured by the Haylett index) posted a year-on-year growth of 6%. The difference between these rates indicates the extent to which building contractors are still stretching their profit margins; furthermore, with building activity expected to remain strong, Rode projects that building-cost inflation will repeat its double-digit growth of last year and come in at about 15%.

Over the last two years, flat rentals grew by just over 6% p.a. in the Durban metro and just short of 12% p.a. in Pretoria, while Johannesburg, Port Elizabeth and Cape Town registered growth ranging between 8% and 10%. With annual consumer inflation just shy of 3% over the same period, landlords did achieve real rental growth. However, investors would have done better with many listed funds, most notably those with high retail and industrial components.

House prices seem to be heading for single-digit growth in the next twelve months. As far as the various price categories are concerned, Rode’s figures show that between quarter 2000:1 and 2005:3, middle-priced houses put in the best performance, whereas the upper-priced and lower-priced suburbs tied for second place. Due to growing unaffordability at the upper end, lower-priced suburbs have been performing better than the more expensive neighbourhoods since early 2004. House prices in lower-priced suburbs are generally below R700.000.