Property Barometer – 2nd Quarter Retail Property Fundamentals – Better or Worse?

Real Retail Sales growth for the 2nd quarter of 2016 was down to 2.6% year-on-year, from 3.5% in the 1st quarter. However, it is not clear cut that the 2nd quarter of 2016 was a worse quarter for Retail Property from an “economic fundamentals” point of view.

For some time, FNB has been witnessing a weakening in economic fundamentals that are important to the strength of the Retail Property Market.

Importantly, the 2nd quarter was a slower growth quarter from a real retail sales growth point of view. From 3.5% year-on-year in the 1st quarter of 2016, real retail sales growth tracked the direction of Real Household Disposable Income growth slower to 2.6% in the 2nd quarter.

Any sign of slowing retail sales growth should raise the risk of an increase in Retail Property vacancy rates, especially given that in 2015 the IPD had already reported a slight increase in the National Retail Property Vacancy Rate, from 4.5% in 2014 to 4.7% in 2015, and that while Real Retail Sales had been growing at a relatively healthy 3.3% for last year as a whole.

Actual vacancy rates aside, there were some indications of an increase in financial pressure in the Retail Property Sector through 2015 and early-2016, with IPD Retail Centre Operating Cost data pointing to a rise in Bad Debts from 70 cents/ square metre/month to R1.35/square metre/month.

Liquidations data for the Retail and Wholesale Trade, Catering and Accommodation Sector, too, while still at low actual levels by historic standards, has nevertheless shown increase over the past year.
Using a 12-month moving average for smoothing purposes, we saw Liquidations for this sector rise by 10.94% year-on-year for the 12 months to June 2016.

So even with Real Retail Sales growth managing to achieve quite healthy rates in 2015 and early in 2016, relative to non-existent economic growth, the environment had still grown tougher for Retailers.
We saw some hints of weakening in the Retail Property Sector early in late-2015/early-2016 in the form of a mild increase in key Shopping Centre Capitalisation (Cap) rates following a multi-year declining trend.

According to Rode data, Witwatersrand Regional Shopping Centre Cap rates appeared to be “turning the corner” towards moving little higher, from a multi-year low of 6.9% in the 3rd quarter of 2015 to 8.1% in the 1st quarter of 2016. The Cape Town Regional Shopping Center Average Cap Rate had bottomed out at 7.6% in the 1st half of 2015 before also rising to 8.0% by the 1st quarter of 2016.

In the latter stages of 2015 and early in 2016, however, what was a mild rise in Retail Property Cap Rates was arguably driven less by the Retail Sales growth situation, because late in 2015 real retail sales growth was going through a minor short term strengthening.

Rather, it is likely that sentiment in the sector was deteriorating as a result of rising short and long term interest rates, a slowing economic growth rate, and deteriorating general sentiment towards South Africa and its uncertain policy situation, as reflected in the sharply weaker Rand especially after the late-2015 “Nenegate” issue.

In the 2nd Quarter of 2016, however, FNB suddenly found many of the key influences on Cap Rates moving in the “right” direction. Slowing Real Retail Sales growth was not one of them, but monthly Manufacturing and Mining numbers amongst others do point to the probability that overall economic growth in the 2nd quarter improved from its 1st quarter 2016 contraction.

CPI inflation, too, “settled” somewhat at not far above 6%, off the high of 7% year-on-year in February, after a late-2015 surge. From its January average, the Trade-Weighted Nominal Effective Exchange Rate Index for the Rand had strengthened by 17.9% up to August 2016 to date. This not only reflects improved sentiment towards South Africa after the passing of Nenegate, some improvement in key commodity prices and avoidance of a ratings downgrade in June, but a stronger Rand also drives some positive sentiment itself.

In addition, Rand strengthening curbs imported inflation, so it is no wonder that the Bond Market has strengthened somewhat and the talk of interest rate cutting is on the rise, helped on by a low interest rate outlook in many other parts of the world.

The result was a sideways movement in the Repo and Prime Rate through the 2nd quarter and 3rd quarter to date, following on 1st quarter hiking, while the Average Government Long Bond Yield has declined from 9.37% in the 1st quarter of 2016 to 8.66% for the 3rd quarter of 2016 to date. During the 2nd and 3rd quarters, therefore, one could conclude that the combined short and long term interest rate situation had switched to becoming mildly supportive of the Retail Property Market, as did the recent Rand strengthening.

This, along with a probable slightly improved economic growth rate in the 2nd quarter, may have offset the negative impact of slowing retail sales growth at least temporarily, and prevented any further rise in Retail Cap Rates for the time being.

Read more here: Property_Barometer_ Retail_Fundamentals_August_2016