While South Africa’s economy remains constrained following a year (2023) of headwinds and challenges that consumers, business and industry alike have had to contend with - including increases in electricity tariffs and municipal fees - Swindon Property has seen strong trading in its Johannesburg and Cape Town markets in Q2 and Q3, while its Durban operation is poised for an uptick in activity in 2024.

Says Andrew Dewey, MD of Swindon Property: “Not surprisingly, given its infrastructure and world-class environment, Cape Town continues to draw investors. While we noted a slowdown in demand for development opportunities, which resulted in very low bulk rate values, we are optimistic that this will increase and improve in 2024, affording sellers the opportunity to trade both greenfield and brownfield opportunities.

“Encouragingly, consumer inflation subsided in Q2, reaching a 14-month low in June 2023. A more controlled inflationary environment and the potential for interest rate cuts in 2024 bode well for facilitating economic recovery. Currently, with no fluctuations in the repo rate creating stability in the market, sellers are more accepting of current capitalisation rates, while buyers are optimistic about seeing improved performance in 2024 - with potential rental and reduced gearing upside across the board.” 

 

Market Trends

Says Mark Govender, a professional valuer for Swindon Property: “As a general overview, the industrial property market continues to outperform the office and retail sectors, while in the office sector, improved vacancy rates are exerting upward pressure on rentals and therefore on capitalisation rates. In the retail sector, convenience shopping centres of 5 000 to 15 000sqm are still a hot commodity with single-digit selling yields in most instances.

“Of note is that we have concluded a number of occupier sales this year and JV’s where occupiers are co-investing with funders. This has proven a very successful model for both parties as the tenure security is needed by the investor, while the debt gearing and experience in commercial ownership are sometimes required by the tenant.

“Our occupier services division is also seeing demand for ‘plug and play’ space in the office sector, especially with the high cost for design and fit out, large warehousing of 5 000sqm+, especially in Johannesburg, while we continue to see a big push for ‘creative work environment’ offices that offer character, identity or creativity.

Adds Govender: “Another interesting trend is that we have seen approximately 90% of all our auction sales being concluded pre or post-auction day, with our marketing campaigns eliciting buyers from far and wide including Africa, America and Europe. We utilise auctions as a transparent method of disposal ensuring the reach with the highest and best offers being secured, however, we continue to decline any mandates we feel where the price point is not in line with the market.”

 

Office Sector

According to a recent Rode Report, average capitalisation rates in grade A, multi-tenanted office properties in SA of 11.1% in Q3 are still well up from the pre-Covid (2019) level of just under 10%. The upside is that these rates have not deteriorated further – possibly as vacancy rates have improved from high levels. As the report points out, this sector is still experiencing an oversupply in the face of sluggish economic growth prospects and the ongoing impact of the work-from-home trend. Regionally, capitalisation rates improved in Cape Town, but is weakening in Pretoria and trending sideways in Johannesburg.

According to SAPOA’s latest office survey results, the national office vacancy rate improved for a fourth consecutive quarter, reaching 15.6% at the end of Q2 (down 50bps from Q4 2022). Within core markets, overall vacancy rates ranged between 9% and 19%, as reflected in Cape Town and Johannesburg, respectively. Johannesburg, Durban, and Cape Town all improved their vacancy levels over the first half of 2023, with total available supply nationally falling to 3 million sqm. SAPOA states that there has also been a rise in the total rentable area of committed new developments through the first half of the year (11%). Despite the increase, however, available lettable area within these developments has dropped by 19%.

Says Dewey: “At present there is approximately 125 000sqm of committed new development nationally, with activity concentrated in Cape Town. Continuing improvements to vacancy levels are likely to slow if the economy is to stay on its stagnated path over the short to medium term. Typically, economic growth of at least 3% year on year is required for meaningful take-up levels to be recorded.”

In terms of office rentals, although Rode’s nominal market data indicates a continued recovery from the low Covid levels, increases are slowing and office rentals in real terms continue to look bleak. Listed property funds are also still reporting large negative rental reversion rates. The important point remains that many companies are still working on a hybrid basis, favouring two to three days a week at the office, which means less demand for space compared to pre-Covid levels. Furthermore, office demand will not see a sustainable turnaround without much stronger economic growth.

Regionally, Cape Town has been the clear top performer since 2022, albeit from a low base in 2021. Nominal grade-A gross rentals in the Q3 of 2023 increased by 12% in the decentralised nodes of the Mother City compared to a year earlier, even exceeding pre-Covid levels by 5%. In absolute terms, Cape Town’s decentralised rents are also the highest of the major cities. Nominal rental growth in the decentralised nodes of the other major cities averaged between 0.5% and 2%. This implies that in real terms, only Cape Town managed to record above-inflation rental growth compared to a year ago.

Dewey says it is apparent that real rental growth prospects remain limited, exacerbated by the demand/supply imbalance, and it may very well be that market rentals are now entering a corrected state. Innovation is required by landlords in terms of tenure arrangements, space utilisation, and the offer of amenities and concessions. The concept of offering office space as a service should be front and centre in the minds of property owners looking to fill vacancies and attract new demand to their portfolios.

 

Industrial Sector

“As mentioned,” says Dewey, “of the three major non-residential property types, the industrial property market is still best placed. Within this sector, demand fundamentals remain robust across a wider range of submarkets when compared to offices. This is due to its low vacancy rates, resulting in stronger rental growth. Nominal gross market rentals for space of 500sqm grew by 3.8% in the Q3 of 2023 compared to the Q3 of 2022. This is slower than the 4.1% year-on-year growth recorded in the Q2 of 2023 and was the third consecutive quarter of weaker growth. This was to be expected, given weaker economic growth and in particular the pressure on the manufacturing and retail sectors. In real terms, rentals are still declining due to high building cost inflation.

“That said, the industrial sector is not immune to headwinds and remains reliant on performance within the retail and manufacturing sectors. Moreover, power supply issues are placing further pressure on rental affordability, affecting both property owners and occupiers. Furthermore, the market is nearing saturation for large-scale super-warehouses and distribution centres, with focus shifting to the final or ‘last mile’ links in the supply chain. Here the space as a service trend that is shaping office and retail markets is becoming more relevant, with technological and other external factors also coming to the fore. These new baseline requirements are costly to develop and integrate, once again testing the affordability constraints and appetite for absorbing costs of occupiers and developers/property owners.”

According to Rode’s report, In the Q3 of 2023, capitalisation rates of industrial leasebacks in the country’s major industrial areas increased slightly (ie worsened) compared to the Q2 of 2023. Respondents in Rode’s survey opined that investors in prime industrial properties with a leaseback covenant required a minimum net income yield of 9.8% in the country’s top cities and nodes. In today’s market, this is a fair return, provided the tenant is of AAA quality. For comparative purposes, government bond yields of 10 years plus averaged 11.8% in Q3. Looking at the bigger picture, capitalisation rates have averaged 9.8% so far in 2023, up slightly compared to the average 2022 level of 9.7% and still higher than the (pre-pandemic) 2019 figure of 9.4%.

Regionally, capitalisation rates remain the lowest (best) in Durban and Cape Town. Cape Town continues to see strong rental growth and low vacancies due to solid demand. In Durban, rentals have been boosted by low stock levels in the aftermath of the 2021 riots and flooding in 2022.

 

Retail Sector

Dewey adds that the retail property market made a strong comeback in 2022 but has been under pressure in 2023 to date as evidenced by the weaker retail sales performance and higher mall vacancy rates. This no doubt played a role in brokers’ perceptions, with capitalisation rates of regional shopping centres showing an upward trend of late.

Rode’s survey results show that capitalisation rates of regional shopping centres in South Africa averaged 9.7% in the Q3 of 2023, up from 9.4% in Q2. This was the second consecutive quarter of higher (worse) capitalisation rates, which makes sense given the weaker performance of the retail market so far in 2023 versus 2022.

To illustrate, real retail sales on a national level fell by 2.1% year on year over the first seven months of 2023 (ex-Stats SA), while mall vacancy rates rose to 5.6% in the Q2 of 2023 from 5% in the Q4 of 2022 (SAPOA/MSCI data). Most of the major cities surveyed by Rode saw higher (worse) cap rates in the survey quarter. Nationally, weighted regional-centre capitalisation rates are higher than the 2022 level and well up compared to the 2019 average of 7.9%. Says Dewey: “We found that, nationally, the capitalisation rates for the smaller community and neighbourhood centres averaged 10.3% and 10.9% respectively, both higher (weaker) compared to the second quarter of 2023.

“This weak confidence data is not surprising, given expectations of weaker consumer spending amid high interest rates and elevated prices of food and fuel. This will continue to put upward pressure on retail capitalisation rates in the short term. Anecdotal evidence that the consumer is under significant financial pressure, is that the demand for solar power installations on houses has now slowed, although the demand by corporates is strong.

 

Looking Ahead

“On a positive note, to end the year, the Monetary Policy Committee left SA’s key interest rate unchanged at 8.25% for a third consecutive meeting, in line with economists’ expectations. 

“This comes after annual consumer price inflation leapt to 5.9% in October from 5.4% in September, closing in on the upper end of the SA Reserve Bank’s targeted band of 3% to 6% and marking a third month of increases. However, the stable repo rate augurs well for consumers, property owners and investors going into 2024, with some economists believing we will see interest rates cuts as early as March next year, bringing some relief to the economy.”

Concludes Dewey: “The Reserve Bank’s gross domestic product outlook improved, with it forecasting 0.8% growth this year, up from 0.7%, and increased it to 1.2% next year. This was after spending by firms, households, public corporations, and general government remained positive in real terms on an annual basis; the disposable income of households expected to grow, albeit slowly; the investment forecast for the year was revised up to 7.7% in September and credit growth to households and corporates slowed but remained positive.”

 

For further information contact Swindon Property on +27 (21) 422 0778.