Increased office demand points to upturn in office property market
01-10-2003
Office demand in South African cities generally seems to have taken a turn for the better. If this continues, say property economists Rode & Associates in their latest review (quarter 2003:2) of the property market, it can only spell good news for the office property market.
Rode & Associates view office demand, and not office vacancies, as the most crucial indicator when determining the inherent health of the office market.
Meanwhile, office rentals are still sliding — particularly prime CBD rentals. Durban's CBD has again performed the best with a real contraction of ‘only’ 0,7%, while Johannesburg was worst hit with a real contraction of 31%.
Real office rentals in the decentralized areas of Johannesburg and Cape Town were still firmly nestled in their downswing, whilst in Durban and Pretoria decentralized, it seems as if real rentals could be levelling off. "Interesting, though, is that the rental gap between the cities’ decentralized areas is closing, with especially the Pretoria suburbs catching up," says Rode's Report editor Dirk De Vynck.
The relatively better performance of Pretoria decentralized office rentals can be explained by the strong office demand in the area, which, according to Rode's calculations, showed a take-up of 140.000m² in the twelve months to the end of June 2003.
Nationally, CBD office capitalization rates (non-listed equivalent of the forward earnings yield on shares) finally seem to be levelling off at the 18% level. However, it is highly unlikely that CBD office capitalization rates will improve (come down) substantially from these levels. This is so because, for most of the CBDs (barring Cape Town); there is little hope of a drastic turnaround from the decay. Rather, these CBDs will have to transform themselves into mixed-use nodes catering for the emerging petit bourgeoisie.
For the other property types, there was still no deviation from the increasing (weakening) trend in capitalization rates, which has been evident since 1996. This, of course, implies that investors’ increasingly negative perception, created by the current oversupply of non-residential space, has not changed.
The quarter under review saw no change from the depressed state the industrial property market has been in since at least 1990, with real rentals and stand values continuing on their secular downward path.
"However, in nominal terms, Port Elizabeth seems to be the only industrial conurbation where an improvement has been noticed over the last year. Port Elizabeth’s steady increase can in all likelihood be attributed to heightened activity in the motor vehicle and related sectors," says De Vynck.
Real flat rentals in the major metropolitan areas were still in a consolidation phase in quarter 2003:2, although some cities started showing signs of an upturn. As for Johannesburg, it seems as if real rentals may finally be slacking off, as Rode predicted in their previous Report. "It just did not make sense for real flat rentals in the Johannesburg metro to steam ahead while all the other cities’ real rentals were declining.
The most likely reason for the slowdown in real flat rentals is an oversupply of rental accommodation brought on by the increased townhouse-building activity to satisfy the growing investor interest in the buy-to-let market, which was partially caused by the bear markets on SA and foreign bourses, which prompted investors to look for alternative investment vehicles. “But note that this is only a slowdown — we are still seeing real growth in flat rentals."
On average, real house prices were still firmly in an upswing in quarter 2002:4, with the upmarket suburbs putting in the best performance. Despite this, Rode’s calculations show that, on average, house prices were typically still well below replacement (building) costs in the last quarter of 2002.
The only exception is Cape Town, where prices in upmarket suburbs have been above building costs since the late 1980s. A possible explanation for this is that supply is inelastic (supply does not respond readily to the growth in demand) because of the scarcity of available land for development, especially on the Atlantic Seaboard and in the Southern Suburbs. With this in mind, it seems highly unlikely that house prices will dip below replacement costs. As for middle- and lower-priced suburbs in Cape Town, house prices and replacement costs were on par.
"Turning to listed property, our latest updated analysis shows that this asset class was trading at a premium of about 9% to directly-held property at the end of quarter 2003:2. But, July and August 2003 saw the listed property sector come down slightly, implying that listed property has, since the end of quarter 2003:2, lost some of its trading premium relative to unlisted property.
"Still, we do not expect that this will deter institutions from listing directly-held property portfolios, because being part of the JSE increases these portfolios’ liquidity dramatically. As it stands, some major institutions — Absa, Sanlam, RMB and Old Mutual — are reportedly considering listings over the next 12 months," says De Vynck.
