High vacancy is not all bad

08-02-2005

Even though market rentals of non-residential properties are expected to show solid growth this year, it will be declining vacancies rather than rental growth that will drive the income streams of listed funds.

Rode’s Report editor Garth Johnson says that a lot has been made of the anticipated effects of strengthening fundamentals, meaning reduced vacancies and growing rentals, on the income streams of listed funds. “Escalation rates have been around the 10% mark for a number of years, despite the fact that market rentals have performed poorly, which means that the expected strengthening of market rentals can be viewed as a catch-up exercise”, Johnson says. Therefore one could find that a tenant with a 36-to-60month lease that expires in the next year or more, may end up renewing his lease at a market rental that does not differ markedly from the last contractual rental he paid. The implication of this is that — new acquisitions, extensions, and revamps aside — listed funds’ income streams will, in all probability, not be driven by growing rentals, but rather by falling vacancies.

Johnson adds that caution should be exercised as to the geographic composition of a portfolio’s vacancies. “Where vacancies are structural and not cyclical, such as in the Johannesburg CBD, solid economic growth may not be enough to attract new tenants”, he says.

The message for investors is thus clear: focus on funds with above-normal vacancies in good nodes.