Rentals leverage industrial stand values
08-06-2005
Robust growth in industrial-stand values in Cape Town, Central Witwatersrand, Port Elizabeth, and Durban over the past year has considerably outpaced rental-growth rates, notes Rode & Associates in the latest Rode’s Report (2005:2) on the state of the property market in South Africa.
This sharp rise in the value of industrial land, confirms past observations by Rode that rapidly rising industrial rentals act as a leverage that pushes up the value of industrial stands at a much faster rate.
To understand how this leveraging takes place, it helps to know that developers typically perform a residual calculation when valuing land, says property valuer and economist Erwin Rode. He explains that they calculate the income that their planned development will generate and deduct from that the cost of the development, as well as their required profit. The balance (or residual) is the maximum they can afford to pay for the land.
When the rentals of the improvements on the land start rising, the value of the underlying land rises even faster. Assuming all other factors stay the same, the Rode team estimates that a 10% rental increase will result in a land value increase of about 86%. Of course, all things don’t stay the same, but in a low-vacancy environment the net result is still that land values grow significantly faster than rentals.
A historical comparison of market rentals and stand values by the Rode team, showed that market rentals generally tracked the market value of stands during the 1990s. However, between around 1998 and 2003, rentals started moving sideways, which, given increasing building costs, resulted in falling land prices. Since 2003, they noted a reversal of this trend. This confirms what Rode’s leverage theory suggests — that land values are much more volatile than market rentals.
Considering the leveraging effect, the current rapid rise in industrial rentals means that it is better at the moment to invest in the underlying land than in the improvements.“It is important to get the timing right”, cautions Rode. “Watch rental movements more than other factors. When rentals start levelling out and moving sideways, land value increases will stop and when rentals start to decline, land values tend to drop even faster.”
