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Commercial property owners’ worst fears were realised in 2019

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The start of 2020 could not have come sooner for commercial property owners who said good riddance to a year fraught with struggles and challenges.

Among the biggest were property rates, load-shedding, site invasions and municipal inefficiencies, all of which resulted in investors taking money out of the country, says Neil Gopal, chief executive of the South African Property Owners’ Association (Sapoa).

The economy “has barely grown”, investment has “dwindled” and the unemployment rate increased. All of this resulted in a particularly challenging year for commercial property owners.

“Today we still feel the effects of several years of corruption, the erosion of important public institutions and the resultant policy malaise. The property sector has felt the effects at an alarming rate in the form of a weakening economy, decreasing investor confidence, rising municipal costs, water and electricity crises and high tenant vacancies.”

In addition, Sapoa’s Gopal says the Competition Commission’s finding on rentals at the end of last year was a lowlight of 2019.

“Regulating rentals in a free market system, where the market corrects itself, is unsound and will have significant unintended consequences, particularly as the findings were made with no credible research. The risks associated with this will result in fewer retail facilities developed in South Africa.”

The commission’s report found smaller, often independent tenants were generally charged higher rentals than large anchor tenants in malls.

For Erwin Rode of Rode & Associates, the poor fundamentals of the past three years (lack of growth and too much building) that have now “trickled down to poor investment performance” were the biggest negative for the commercial property market. Major challenges owners faced included retaining tenants whose rentals had escalated to “well above market levels” and replacing those who chose to rent elsewhere.

This year, he says, the struggle to show distribution growth above the inflation rate will intensify on the back of a stagnant economy.

“Pressure will come from two sources. Firstly, lack of growth in market rentals and escalated rentals that will revert downwards to market levels on renewal of leases, and secondly, market values marked down by valuers in the wake of slightly rising capitalisation rates and stagnating or declining cash flow negatively affecting net incomes.

“Portfolios that have been overvalued are especially at risk because auditors are under pressure to scrutinise valuations.”

The “very weak” economic growth rate last year had implications for all three major property sectors, says FNB commercial property economist John Loos. Weak retail sales growth impacted on retailers’ profitability and demand for retail space; weak manufacturing production growth had implications for industrial space demand; weak employment growth in the finance, real estate and business services sector impacted on the demand for office space.

“Therefore, 2019 was characterised by weak demand for rental space, which in turn translated into a further rise in the average All Property Vacancy Rate. This rising vacancy trend has been on the go since 2016, from 4.18% in H1 (first half) 2016 to 6.65% by H1 2019. These weakening demand-supply fundamentals in commercial property have likely translated into lower All Property Returns in 2019.”

Furthermore, Loos says capital growth on property “across the board” looks likely to have been negative in real terms (when adjusting for general economy-wide inflation), and possibly even in nominal terms.

While much has been said about technological progress bringing the online shopping threat to retail and remote working threat to office space, this is probably the “minor partner” in terms of pressure on the commercial property sector.

“I still believe economic weakness was the major challenge. As the weak economy exerts pressure on the tenant population, this reduces landlords’ ability to ‘price’ and has made key operating cost items, notably municipal rates and utilities’ tariffs that have risen sharply, a key issue for tenants and landlords,” Loos says.

The country’s social and economic failings, including xenophobia and domestic and other violence and the failure of key state-owned enterprises (especially Eskom), were the biggest negatives of last year, says Frank Reardon, chief operating officer of Fundamentum. Trade wars and Brexit weighed down international sentiment.

He predicts this year will also be challenging, with the upside being positive action and direction on state-owned enterprises and rampant corporate and government corruption “that has crippled South Africa”.

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