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The economy and property market have not yet ‘fully recovered’

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The rapid and perhaps “easy” part of the economic and property market “rebound”, following the 2nd quarter 2020 lockdown dip, appears to be over. From here onward, it is time for the “hard yards” back to being “fully recovered”, says John Loos, Property Strategist at FNB Commercial Property Finance.

Unlike the home buying market, which is highly interest-rate sensitive, the Commercial Property Market is more strongly influenced by trends in economic growth, says Loos, and the economy to date has only “partly” recovered.

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He explains that by “partly recovered” he refers to a real GDP (Gross Domestic Product) level (not growth) that remains below that of pre-lockdown levels. As of the 1 st quarter of 2021, real GDP was still -3.2% year-on-year down, i.e. -3.2% below the level of the 1st quarter of 2020. Therefore, while a lot better than the sharp -17.8% year-on-year dip in the 2nd quarter of 2020, domestic output has not returned to pre-Covid 19 levels and the pace
of quarterly improvement has slowed, the 1 st quarter negative growth rate has only improved by 1 percentage point on the previous quarters -4.2%.

The simple reasoning for the last part of the recovery is slow is that a portion of the productive capacity of the economy, i.e. businesses, closed their doors permanently during the lockdown-driven economic shock. Over time, others will step in to fill the gap with the expansion of their capacity or the creation of new production capacity.

But this takes time because many surviving businesses took a significant financial knock themselves, so business confidence is low, and caution is widespread.

Therefore, given that the Commercial Property Sector is strongly influenced by the economy’s path, it is not surprising that we have seen certain key property market-related data also seeing its pace of improvement slow after an initial sharp rebound.

Noteworthy in this regard has been TPN’s data relating to commercial tenants in good standing with their landlords about rental payments. After a bounce-back from a 41% low in May 2020 to 60% by October 2020, the percentage of retail tenants in good standing moved more-or-less sideways to 61% by March 2021, remaining stubbornly below the 72% level of March a year ago just before hard lockdown.

Office tenants showed a similar lack of further progress, their percentage in good standing hovering near 71% from November 2020 to March 2021, also still below the 75% pre-lockdown level.

Only Industrial tenants in good standing, at 69%, made it back to the 69% pre-lockdown level, of the major 3 commercial property classes.

FNB Property Broker Survey also points towards a significant rebound since hard lockdown, but not yet “full” recovery

Examining the 2nd quarter 2021 FNB Property Broker Survey, Loos says that brokers as a group don’t yet imply “full recovery” with their survey responses either, but do suggest some greater market stability, as earlier rising vacancy rate trends may have subsided.

However, the brokers still point to all 3 major commercial property markets being heavily oversupplied in terms of properties on the market for sale. “And”, Loos says, “such survey results lead us to believe that the decline in average capital values of commercial properties that started in 2020 may not quite be over yet”.

“The broker survey continues to point to the Industrial Property Market being the strongest of the 3 major markets”, he says. “However, what has changed since 2020 is that the brokers are now seeing Office Property as the weakest of the 3 markets, whereas Retail has made something of a “comeback” in 2021 to date, from having been the weakest performer in 2020”.

Property Market Prospects

So what then of the near-term prospects? Loos says that, if one includes property classes outside of the major 3 commercial classes, he expects the Hotel Property to have another very weak year, and underperform all 3 of the major 3 commercial property sectors.

The Hotel Sector still battles from foreign tourist restrictions, much dependent on the progress in vaccine rollouts and getting Covid-19 under control. But he says that Covid-19 is not the only constraint on the Hotel Sector going forward.

The recession of 2020 gave domestic households a major financial knock, and when this happens it is often non-
essential spend such as holiday spends that is placed on the backburner. In addition, corporates have “zoomified” many of their interactions that previously involved travel and hotel stays. He thus believes that a portion of corporate travel and hotel stays will not be returning.

About the major 3 property classes, he expects Office Property to be the underperformer for 2021 as a whole. Encouragingly, the FNB Broker Survey in the 2nd quarter points to a perception that the rising office vacancy rate trend may have stalled, although the buying/selling market for office space is still heavily oversupplied. But with MSCI data that has shown the average office vacancy rate to have reached a near 15% average last year, and likely significantly higher by year-end, he doesn’t expect that market rentals in office space will end their decline just yet.

Beware of the “Hype Cycle” While property investors may battle to find a balanced perspective regarding office property in the remainder of 2021, Loos elaborates on a form of what Gartner and Co have termed the “Hype Cycle”, which refers to cycles of over-expectation followed by disillusionment when a certain technology shows great promise.

While the forced lockdown-related Work From Home (WFH) “experiment” of 2020 was not technology-driven but rather Covid-19 driven, the available technology that enabled the success of WFH was a big part of its success and resulting hype.

This led to a huge amount of hype around the future of WFH, and in many instances perhaps an over-expectation of how quickly many more people would work from home, and how rapidly office space would become obsolete.

Loos believes that the WFH hype was likely overdone, not because it doesn’t have a big future, but rather because some had perhaps expected too much WFH too quickly. As a result, we are now likely to see some disillusionment to follow as many returns to the office slowly but surely.

Loos says that he believes that neither the extreme hype nor the disillusionment that follows, will necessarily be in line with reality.

“The reality is that many jobs can’t be WFH jobs, and certain parts of jobs require face to face interaction. Our view since lockdown began was that the long-term trend towards greater WFH, in play for decades already as enabling technology develops, has received a boost by forcing late adopters to try WFH out. But first, the level of WFH needs to drop, as and when economic life normalises, and then begins to resume the longer-term rising trend, at what I believe will be a faster rate than pre-the lockdown rising rate.”

What is misunderstood about WFH is that the rising trend doesn’t only mean a greater portion of the workforce working full time from home, but also the office-based population spending a greater portion of their time working remotely.

This enables office space-saving by companies through a move away from reserved desk space to “hot desking” and “hotelling”.

On top of WFH, the Finance, Real Estate and Business Services (FREBS) Sector shed some 7.5% of its employment in 2020. With FREBS Sector employment being a key driver of office space demand, that alone may result in office space cutbacks by companies.

“In the area of Retail Property”, Loos says that “FNB card spend data has shown strong growth in online spend, but online retail remains a minor partner in retail sales, and according to our FNB Broker Survey has been less of a source of pressure on retail than what the brokers perceive WFH to have been on the office market”.

Meanwhile, Loos says, the Industrial Property Market looks set to remain the relative outperformer, benefiting from greater interest in the logistics required for a bigger E-commerce future to come, while also being the most affordable class of property of the major 3 classes.

In closing, Loos says that he expects 2021 to be a year of further negative capital growth, albeit at a diminished rate in the case of Industrial and Retail Property, with those 2 property classes going back into positive capital growth in 2022. Hotels and Office space, he believes, may take longer to return to positive capital growth, expecting this only to happen in 2023.

While the economy is forecast to grow positively in each of FNB’s forecast period years to 2024, he warns that the property market is expected to have some “dampening” pressure from a forecast rise in interest rates, starting with 50 basis points’ worth in 2022.

Coastal regions appear in better shape than Gauteng

Malusi Mthuli, FNB Commercial Property Finance’s KZN Regional Manager, meanwhile, believes that the country’s coastal regions have in part “bucked the trend” of severe weakness that came with the 2020 recession. He believes that KZN being home to one of the busiest harbours continues to offer good prospects for the Industrial Sector.

Other than the Dube Trade Port and Cato Ridge precincts, the region lacks any expansive land release that could have a meaningful impact on industrial land supply. He acknowledges the inefficiencies in goods-handling capacity of the harbour, which he believes creates a strong case for investing in logistic facilities within KZN.

The scarcity of flat terrain minimises the supply of suitable development opportunities. All these factors play into the hands of current and prospective investors.

Therefore, he believes that properties in the Industrial Property Sector of KZN have been an outperformer, and indeed this is what the FNB Property Broker Surveys in recent years have also pointed to. He says that the Western Cape enjoys similar attributes of supply and demand.

He goes further to say that “KZN is one of the most populous provinces in the country. It thus comes as no surprise that the residential sector continues to grow, underpinned by the availability of cheap finance, the flexibility of work that enhances semigration, and coastal lifestyle.

The movement towards the north coast has unlocked new property investment opportunities, along with lending opportunities for FNB Commercial Property Finance both on the development Finance and end-user perspective.”

Finally, Mthuli says that “smaller towns in areas that are often referred to as rural ‘dorpies’ continue to surprise many through this tough economic period, often posting above-average returns for investors. Retail trade in these towns remains relatively unshaken by the turmoil brought by the pandemic.

The catchment areas of these towns are driven by the lower end of the market, the Agricultural Sector that has been rallying of late, and basic needs spending which is less affected by the changing macro environment.”


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