2019 Property-Related Focus Areas – Electricity likely to be one

Looking ahead to the next year some of the key potential property-related “themes” have already start to emerge. While interest rates have grabbed most of the attention this week, electricity supply and costs look set to be a key focus area for property owners as 2019 approaches, with power utility Eskom looking to obtain double-digit annual tariff hikes over the next three years.

Electricity looks set to be a key source of attention for the property sector. Its impact on the property sector has already been significant to date, and Eskom’s weak financial situation poses the risk of further impact. The question is how can it impact on the property sector? The answer is …”it depends”. Given recent revelations of increased maintenance issues and coal supply constraints, raising the risk of periodic “load shedding”, the one obvious potential impact on property is via the potential impact of electricity supply limitations in constraining economic growth and thus the demand for property.

Then there is the high level of Eskom debt at a time when its electricity sales battle to grow, with the utility reportedly having over R400 billion worth of debt and rising. Does this debt, along with rising general government debt begin to exert upward pressure on yields in the bond market? That’s a potential source of upward pressure on property capitalization (cap) rates.

But a key concern would arguably be the granting of the requested 15% electricity tariff hikes each year for the next three years, which may contribute to saving Eskom financially in the near term, but would contribute significantly to increases in property operating costs at a time when many property occupants may be battling as a result of the weak economy.

On the residential property side, sharply rising electricity costs (along with municipal rates and other utilities tariffs) have long since been a housing-related affordability challenge. The Consumer Price Index for Electricity is used to compile a Electricity/Per Capita Income Ratio Index starting in 2008. It shows that electricity tariff increases applied to consumers have far outstripped Per Capita Income growth, with this index increasing by a massive 82.71% from 2008 to date.

This provides a strong incentive for households to lower electricity consumption or to cut broader operating costs on the home to compensate for the sharp electricity cost increases, and one way of doing it is to purchase a smaller home with less “frills”, such as swimming pools which can add to operating costs significantly. The other way is to cut electricity costs, either through more energy efficient homes of alternative energy sources.

Not surprisingly, therefore, it is expected that the average building size for new residential properties will decline, in part helped smaller by rising electricity costs.

Over time, sharply rising electricity costs also “crowd out” disposable income, some of which would otherwise be aimed at funding property purchases.

Using SARB Household Consumption Expenditure data, we see the portion of total consumer spend being spent on “Household Fuel and Power” as having risen from 2.1% in 1975 to 3.0% by 2007, and then more sharply to 4.69% by 2017 in part due to sharp increases in power costs over the past decade.

The operating cost picture, however, can be severe on the commercial property side too, especially in the area of retail property. For all commercial property, IPD data shows electricity costs in terms of Rand/Square Metre/Month rising by a massive 611.4% from the year 2000 to the first half of 2018. This is compared to 342.1% for Total Operating Cost over the same period, and only 277.7% increase for total operating cost/square metre excluding electricity.

In the process, this has meant that the electricity cost component of property operating costs has risen from 19.2% of total operating cost in 2000 to a first half 2018 percentage of 31.1%.

Electricity has thus become a big deal for property owners and occupants over the past decade or two.

This most recent 31.1% estimate was slightly down on the 34% high of 2017, with electricity price inflation having been more moderate recently. But recent reports on Eskom suggest that its financial pressures continue, hence the requests from the regulator for a return to double-digit tariff increases. Should such increases be granted, a renewed increase in the electricity component’s share of total operating costs is possible.

This then begs the question as to whether property such cost increases, in a toughening economic environment, would “crowd out” a portion of rental growth that otherwise may have occurred in a stronger market.

While the electricity cost portion of operating costs is highest in the area of industrial and warehouse property (35.4%), retail Property operating cost in terms of Rand/per square metre/month is far higher than industrial and warehouse property, so the electricity cost/square metre/month in retail property averages R29.3, compared to a far lower R15.3 for office space and R6.6 for industrial and warehouse space.

The potential impact of major electricity tariff hikes would appear highest in the area of retail property, therefore.

In short, electricity supply and costs are likely to be key economic news in 2019, as government grapples with how to turn Eskom’s finances around. Power supply reliability has economic growth impacts, while the debt of the power utility poses bond market and cap rate pressures. But a key direct impact would be that of major electricity tariff hikes on property operating costs, especially in the area or retail property. In residential, such cost increases make smaller less luxurious properties relatively more popular than larger ones that are costly to maintain and run. In commercial property, “green buildings” can benefit in terms of relative appeal, while cheaper forms of retail such as online retail can receive a “relative” boost.

Read more here: Property Insights – Electricity – A 2019 Focus – 23rd November 2018