Advice and Opinion

High municipal rates resulting in commercial properties becoming very expensive to maintain

Interest rate increases and escalating municipal costs, including electricity and water costs, maintenance services and municipal property rates, are resulting in commercial properties becoming very expensive to maintain, and in turn is lowering the demand for this type of property in South Africa.

This is according to Gary Palmer, CEO of Paragon Lending Solutions, who says that five years ago municipal bills as a percentage of operating costs were around 40%. “Today these costs have escalated to around 66% of operating costs. The impact is continued pressure on net property incomes, especially where landlords are unable to pass on cost increases to tenants. Increasing costs and the downward pressure on rentals has resulted in a margin squeeze in this sector.”

He says that consequently commercial property portfolios are becoming too expensive to manage, and the inability of tenants to absorb these increases is weighing commercial property owners down. “With interest rates and municipal charges increasing steadily, it will prove difficult to obtain the required funding for commercial property from traditional lenders such as banks, as the high costs that commercial property owners have to endure leaves little margin for them to meet the banks strict lending covenants as well as draw sufficient income for themselves. We will see the banks reducing their loan to values for commercial property deals in the next few months.”

According to the latest house price index by the UK Economist magazine, South African residential property is in high demand, with markets outperforming other global markets by attaining 456% growth in house prices over the last 13 years. “Surprisingly, residential property is proving to be a better investment choice than commercial property. This is due to the fact that the cost associated with owning residential property is less than commercial property.”

Palmer explains that he has seen a remarkable increase in the number of clients seeking funding for residential property transactions as opposed to commercial property deals. “Over the last few years most of the transactions we financed were for commercial properties. There has been a major change over the last few months as clients are now being attracted to the yields achieved in residential property.”

Palmer cautions that the sharp increases in municipal rates are unsustainable not only for commercial property owners, but for the tenants too as commercial property owners have to pass on the increase rates to tenants. Most of the tenants cannot afford the increase and will in all probability not extend their leases when the lease term expires. He says that this will lead to high vacancy rates within the industry in the near future.

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