It will be a tough year for commercial property demand and growth due to a weak economy and increased load-shedding as property owners battle high operating costs.
Though the industrial property sector will continue to outperform the retail and office property sectors, demand for this asset class may have been peaking for some time as rising interest rates and a weakening economy take their toll, according to FNB.
The bank says the office sector — battling high vacancies before the pandemic as occupiers reduced or gave up space — will continue to feel the pain as national vacancies remain in double-digit figures.
The retail property sector will be challenging as rising rates will reduce consumer disposable incomes, reducing spend at malls.
FNB Macro Property Outlook figures suggest interest rates may have peaked after an increase of 425 basis points since late 2021 and may move sideways for the rest of 2023 and into 2024.
In March, the prime rate reached 11.25% after the Reserve Bank’s recent repo rate hike.
“The full effects of rising interest rates are yet to be felt, and this leads us to believe that along with a slower economy, the commercial property market performance will remain weak,” said John Loos, property sector strategist at FNB Commercial Property Finance.
Loos said the added pressure of increased load-shedding with property owners still having to invest vast amounts in alternative power creates an environment in which growth is difficult to achieve.
“We are forecasting a slower growth rate of 0.1% from 2% in 2022 on the back of global economic slowdown, high interest rates in SA curbing demand for commercial property,” Loos said.
The FNB Commercial Property Broker Survey for 2023’s first quarter shows that sales activity in the industrial, office and retail sectors was lower than in the previous quarter due to rising interest rates, Loos said.
Reserve Bank data reflected a 5.67% year-on-year fall in the value of commercial mortgage loans granted in the fourth quarter of 2022 with year-on-year drops in five of the past six quarters to end-2022.
According to the MSCI SA annual index for December 2022, SA investment property returns recovered to above-inflationary levels driven by capital growth, which returned to positive territory for the first time since 2018.
Income return fell to 8% from 8.1% in 2021, with net operating income down 0.9% as property owners struggled with rising operating costs.
Vacancies remained at 8.4% with top line rental growth rising from a negative 2.2% in 2021 to a positive 4.3% in 2022.
Loos said the bank expects income return to rise from 7.86% in 2022 to 8.14%. Capital growth will reach -0.50% from 0.78% in 2022, total return will fall to 7.64% from 8.70% in 2022 and vacancies rise from 8.36% to 8.50%.
Weak performance
Loos said that compared with office and retail, industrial property is the most affordable and most adaptable with lower vacancies so it is at an advantage when the economy is under pressure.
But he said that real seasonally adjusted manufacturing gross value added, a key driver of industrial space demand, was -9.3% below its end-2018 high, and showed growth of only 0.3% year on year for the first three quarters of 2022.
“Economywide inventory levels have also declined significantly in recent years, so the traditional economic fundamentals related to industrial property are not overly strong,” said Loos.
Due to slower economic growth, real household sector disposable income growth is expected to slow from a positive 0.8% in 2022 to a negative -0.2% in 2023, said Loos. This will affect the retail sector as consumers spend less. Average interest rate on household debt is projected to be significantly higher in 2023 than in 2022.
Offices
According to MSCI, the pandemic hit the office sector hardest as many occupiers gave up or reduced space, and it remains under pressure.
In 2022, the office sector had a slight improvement with total returns rising from 0.7% in previous years to 6.6% in 2022. But capital growth was 1.5% down while income return held steady at 8.2%.
Office vacancies remained unchanged at 18.4% with rental growth up 0.7%.
According to the SA Property Owners Association (Sapoa) Office Vacancy Report for the first quarter of 2023, vacancies fell slightly from a peak of 16.7% in 2022’s second quarter to 15.8%.
In 2021’s fourth quarter, office vacancies rose to a new high of 16% from a high of 15% recorded in 2003.
In its interim results for the period ended February, Redefine Properties, which owns an office portfolio of predominantly A and Premium grade, reports a rise in demand for its properties, with vacancies falling as space is taken up.
Valued at R22.2bn, the portfolio of 102 properties is made up of 50% premium grade, 36% A grade and 14% secondary grade including government-tenanted offices comprising 5% of value. Premium-grade office vacancies were 6.7%.
“We are seeing increased demand for our premium offices and the flight to quality continues to be a trend which bodes well for our portfolio,” COO Leon Kok told Business Day.
Kok said that the office sector has generally been weak for some time. For property fundamentals to improve, the economy needs stimulus. Employment levels will need to improve to stimulate demand for office space.
“Rising costs, lack and cost of energy, low economic growth, illiquid financial markets and higher interest rates will continue to shape our operating environment,” he said.
Kok said the group, which owns a diversified portfolio of assets in SA and Poland, continues with its strategy to optimise its property portfolios. During the reporting period, the group sold noncore assets valued at R1.4bn.
He said the group is focused in a tough economic environment on preserving value through organic growth, asset optimisation and prudent capital allocation.
“We believe that our well-diversified asset portfolio and quality tenant base, which drives strong cash generation, will enable us to deliver sustainable returns for our shareholders,” said Kok.
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