Key research findings:
– The latest SAPOA CAP and Discount Rate Survey indicates for the six months to November 2016, the All Property discount rate strengthened slightly to 14.6% from 14.8% in May whilst the aggregate cap rate was virtually unchanged at 9.4%.
– South Africa’s long bond yield now weakened by 200bps since May 2013 – a move which isn’t yet being mirrored by valuation fundamentals, suggesting that we might be approaching the peak of the current rate hiking cycle. As at November 2016, the 10 year government long bond yield stood at 9.0% – a six year high.
– The latest economic data suggests that the SARB may take an increasingly cautious approach to raising interest rates given weak economic growth and other pressures on the consumer. Supporting this notion is the fact is that the latest IPD figures suggest that valuers aren’t passing the full rental growth achieved by properties through to its capital growth – implying negative sentiment among valuers.
– The fact that the long bond yield weakened more than the discount rate during the past six months, raises some questions around the current pricing of risk. The current spread between the discount rate and long bond yield implies a lower level of market risk – or in other words. investors demanding a a lower return in excess of the riskless rate. The current spread is similar to that of 2007 and 2009 when real GDP growth exceeded 5% and 3% respectively.
– The current spread between the cap rate and long bond yield, though improving, suggests limited room for yield compression – in other words, limited room for further capital upside as a result of re-pricing risk.
– Whilst the current perceived miss-pricing in the market isn’t necessarily going to lead to a correction in capital values; its something to be aware of as we approach the peak of the current interest rate up-cycle and places an increased emphasis on factors that have the potential to offset value declines such as higher retention rates, longer leases and tight operating costs management.
– The aggregate discount rate strengthened by 20bps over the past six months but an analysis of the underlying property types suggests a mixed picture with almost as many segments weakening as there are strengthening.
– The largest increase in discount rates over the last six months was in the Durban and Johannesburg CBD office markets which saw an increase of around 100bps. The risk premium reflects the high office vacancy rates in these nodes which is putting pressure on asking rentals and as a consequence, returns.
– Discount rate increases were also reported for light manufacturing units, non CBD tertiary office and Cape Town CBD offices which indicates the excess return investors are demanding from assets with a higher perceived risk.
– As expected, valuers have ratcheted up their assumptions around perpetual cost growth in the last 12 – 18 months. Eskom’s approved tariff hike of 9.4% for 2016/2017 has likely come into valuers’ reckoning as this may impact on landlord’s net income yield. The negative impact of higher perpetual cost growth was in part offset by a higher perpetual rental growth assumption.
Read more here: SAPOA CAP & Discount Rate Report