Robust industrial rental growth, but prime office rentals disappoint
29-09-2005
Industrial rentals continued to grow at double-digit rates in most of the major industrial conurbations during the second quarter of 2005. This happened on the back of the upsurge in manufacturing kindled by declining interest rates. In most cases, real growth was just missed as building-cost inflation of about 17% proved hard to beat.
These findings, based on country-wide data, is contained in the latest Rode's Report on the state of the SA property market just released by property economists and valuers Rode & Associates.
The robust industrial-rental growth and diving capitalization rates continued to leverage industrial stand values during the second quarter, with only Durban’s stand values failing to beat building-cost inflation. Capitalization rates — the non-listed property sector’s equivalent of the forward earnings yield of shares — decline when prices rise.
Although nominal grade-A office rentals in both the decentralized nodes and the CBDs ticked upwards in the second quarter of this year, real rentals contracted. This is despite the fact that vacancy rates have come down sharply over the last year and are, on the whole, quite close to ‘normal’ levels. Rode & Associates CEO Erwin Rode says his team calculated that current grade-A gross market rentals in areas such as Bryanston, in Johannesburg’s northern suburbs, and Tyger Valley, in the Cape Peninsula, could be as much as 65% short of the rental required to make a new development viable. “This is a harbinger of what is to come”, said Rode.
House-price growth decelerated sharply during the second quarter of 2005 and Rode's Report predicts that this process will continue. Absa’s national house-price index indicates that house prices in August 2005 were 19,2% higher than the same month a year earlier. However, more revealing was the fact that the annualised month-on-month growth rate was a mere 7,7%, confirming that the housing market is losing steam fast.
Other significant findings or conclusions in Rode’s Report 2005:3 are that listed property yields are expected to remain around current levels in the short to medium term, that vacancies in decentralized office nodes decreased further, and that Port Elizabeth and Durban flat rentals were the best performers over the last two years, and over the last five years.
Over the last two years, flat rentals in the Durban, Johannesburg and Port Elizabeth metros grew at a compound rate of 10 to 11% p.a. In contrast to this, Pretoria’s flat rentals never even got off the ground, while those of the Cape Town metro registered a pedestrian 5% p.a. over the same period. Developers would be disappointed with this performance, as not one region managed to beat building-cost inflation, which grew at a compound 13,1% p.a. over the last two years. Landlords will be very happy, however, because core consumer inflation grew at a meagre 3,7% p.a.
Looking at the level data, Rode’s Report's latest surveys show that rentals for standard-quality 2-bedroom flats in the Johannesburg, Durban, and Cape Town metros average around R2.600/month; Pretoria’s average rental is about 20% lower at R2.200/month, while Port Elizabeth’s is even lower at R1.900/month.
The Rode team expects that listed funds’ income yields will remain low, as the stabilised low interest rate environment is causing many investors to question the wisdom of investing in money-market instruments rather than in property funds where, although the risk is slightly higher, capital returns are more likely. Furthermore, the market seems to have bought into the rosy prognosis for property fundamentals for the next few years. This is likely to give listed funds the leeway to pay more for directly-held property and, hence, drive down capitalization rates further. In addition, property syndicators’ coffers are likely to remain full, which bodes well for more aggressive buying on their part — specifically in the neighbourhood and community shopping centre segments.
Hurdle rates again followed capitalization rates downwards in the second quarter, as it has done since 2003, when capitalization rates first started falling as a result of declining interest rates. (The hurdle rate is the minimum total return, i.e. income yield plus expected capital appreciation, required by investors to induce them to invest in a property). Hurdle rates vary from as low as 14% for regional shopping centres to as high as 17% for office buildings.
According to Absa figures, old houses are currently trading at a discount of only 6% to new houses. “This is rather low, considering that the average South African house is probably around 25 years old, and that houses age at about 1% point per annum relative to new. This is further evidence that houses are fully priced (if not over priced),” Rode added.
During the first quarter of the year, residential gross fixed capital formation was at its highest level in 20 years. With building plans still growing significantly, albeit not at rates experienced over the last few years, Rode's Report expects residential building activity to remain robust.
Non-residential building activity still has some way to go to reach its 1980s peak, but all signs are that this sector is gaining momentum. As a result, non-residential building-cost growth is expected to remain in the double-digit territory owing to strong demand caused by a booming non-residential sector, as well as continued demand pressure from the residential market. All indications are that these demand-side pressures will be compounded by a shortage of skilled artisans.
