Research

Property market ‘correction’ expected to continue in 2021

Commercial property

In FNB Commercial’s recent Property Finance 2021 Property Market Outlook briefing, it was evident that 2021 will not be without challenges. Covid-19 will still linger across the world albeit creeping closer to the vaccine, and South Africa is still facing ‘old structural issues’ that hampers its economic performance.

Nevertheless, FNB expects a positive economic growth year in 2021 after a severe contraction in 2020. However, they do not believe that economic activity in 2021 will be strong enough to stem the tide of rising property vacancies and resultant downward pressure on property incomes and values.

FNB emphasized the importance of being realistic regarding the time frames required for the economy to achieve ‘full recovery’ – ‘full’ referring to where economy-wide production, as measured by Real GDP (Gross Domestic Product), returns to its 2019 pre-Covid-19 levels. A portion of the country’s production capacity has shut its doors and the lost production capacity will only return with a considerable lag as business confidence slowly improves and either new businesses are formed, or existing businesses expand capacity.

The decline in production capacity is accompanied by job loss. Employment in 2020’s third quarter was -10.3% down year-on-year and this implies a loss in consumer purchasing power with consumer demand being the biggest source of final demand for goods and services produced.

When considering demand for commercial space, it is important to consider the level, not the growth rate, in GDP. FNB’s forecast for Real GDP is that it will decline by -8% for the current year, followed by a ‘partial recovery’ during the forecast period. Positive +3% and +0.5% GDP growth rates for 2021 and 2022 respectively are only projected to take Real GDP levels back to 95.2% of its 2019 level by 2022.

Given that the 2019 level of GDP was insufficient to stop a rising All Property Vacancy Rate trend (using MSCI data), FNB expects that lower GDP levels in the 2020 to 2022 period will likely speed up the pace of increase in the All Property Vacancy Rate in those years. FNB expects the All Property Vacancy Rate, after averaging a forecast of 8% for 2020, to jump to double digits to the tune of 11% in 2021 and 13% in 2022.

FNB believes that indicators of ongoing tenant financial pressure support the expectation of further rising of vacancy rates, pointing to TPN’s data regarding property tenants in good standing with their landlords regarding their rental payments. In this data, the percentage of commercial tenants in good standing in the third quarter, following hard lockdowns, was 56.19%, remaining well below the pre-lockdown 77.85% of the first quarter of 2020.

In short, FNB expects the overhang from the shock of the second quarter lockdowns on the economy to permeate the property market in 2021.

Insights are taken from the 2008/2009 Global Financial Crisis recession where the All Property Vacancy Rate continued to rise for another two years following this recession.

2021 is expected to be a period of rental deflation and slowing escalation rates.

The expectation of a national rising vacancy rate implies a period of further rental deflation. Already, Rode and Associates market rental data for the third quarter of 2020 has shown National Decentralised A-Grade Office Rentals/sqm recording their second successive quarter of year-on-year decline to the tune of -3.23%, while National Prime Industrial Rentals/sqm on 500 sqm properties recorded their first quarter of year-on-year decline to the tune of -0.64%.

The weak economic environment has also dampened supplier pricing power across much of the economy, translating into low general inflation. With a CPI inflation rate currently near 3% year-on-year and forecasted to be a still-weak 3.9% in 2021, FNB’s expectation is that the slowing trend in the rate of average escalations on commercial properties is likely to continue next year.

Average decline in commercial property values expected to continue in 2021.

This continued pressure on property income in turn leads to the projection of another year of average decline in commercial property values. FNB had pencilled in an average All Property value/sqm decline of -7% in 2020, and project a further -9% in 2021, expecting a cumulative value decline for 2020 and 2021 near to -15% in total.

Industrial property is expected to be better off than the retail and office property sectors.

All three major commercial property sectors expected to remain under pressure in 2021, but with the more affordable industrial property sector being the best performer of the weak bunch.

FNB sees retail and office property being under significantly greater pressure than industrial property with retail property having to deal with the emerging online retail trend, but more importantly with a consumer weak on finance and weak on confidence. FNB expects the remote work trend and weak services sector employment to lead to some downscaling in office demand.

Low interest rates may keep the residential buying market mildly more buoyant than commercial property but with the residential rental market in the doldrums.

FNB forecasts a further 25 basis point interest rate cut early next year, and they expect the residential buying market to remain more buoyant than commercial Property in 2021. Home buying is tied to a strong culture of ownership. This is different to the commercial property side of the market, where buying versus renting is more about what makes business sense.

The former is more sensitive to interest rates, the latter being more sensitive to economic conditions. However, a more buoyant home buying market is likely to contribute to ongoing weakness in the residential rental market, taking a portion of tenants away from that market and into home ownership.

The residential rental market’s vacancy rates are expected to be higher in 2021 compared to 2020, and a period of average rental deflation is believed to be nearing.

Affordability and “basics” will likely be king in 2021 and for a while thereafter.

On the residential side this means more developments towards the more affordable end of the market are likely to be a key theme.

In retail property it likely means that the more affordable community shopping centres are more of a sweet spot than the larger and more costly regional and super regionals but it also means that amongst smaller property classes we would expect to see “un-glamorous” categories such as storage space outperforming, for instance, the hotels and leisure category, the latter’s demand being largely of a non-essential nature and unlikely to be strong in recessionary times, not even to mention the impact of Covid-19 restrictions and fears.

Will 2021 provide greater clarity around the future of remote work?

FNB believes that 2021 may start to provide greater clarity on the impact of the “Zoom Boom”/work from home trend. Office space already has high vacancy rates and requires some thought around repurposing.

Office space repurposing into high density residential on the affordable end is an old ‘tried and tested’ in the CBDs. But how big will the market be for more upmarket high density residential in prime de-centralised nodes such as Sandton? If less people are going to be working in such nodes in future, due to increased remote working (potentially alleviating traffic congestion too), then will many want to live there as opposed to lower density areas with more space? And how appealing will high density be to higher income earners if they must spend their working days there too? FNB would guard against expecting the remote work trend to accelerate too rapidly, with many corporates still having offices and infrastructure in place for the time being but they believe it has a bigger future in the coming years, and this raises many questions as to how people will choose to live.

Some higher income households may repurpose homes to make them more suitable for work purposes, or alternatively some may ‘buy bigger’. Semigration to coastal regions could receive a mild boost, supporting residential developments in regions such as the KwaZulu-Natal North Coast but, FNB would caution expecting too much movement in such a tough economic and financial environment.

The Western Cape looks to be the ‘solid’ region of the ‘Big 3’ economies?

FNB is of the opinion that the Western Cape has the strongest structural economic characteristics of the country’s ‘Big 3’ economic provinces. It has built up a relatively strong government at provincial and local government levels and is a modern service dominated economy. It is perceived as a ‘lifestyle’ province, which has attracted a strong semigration of skilled and affluent households, supporting its growth potential. It has been one of the stronger performing economic and property regions, and this has been reflected in data such as TPN tenant data where the Western Cape’s residential and commercial tenants both have higher percentage of tenants in good standing than Gauteng and KwaZulu-Natal.

Government finance still has major implications for property performance

Government is likely to remain a key influence on property in 2021. The additional debt that National Government has accumulated to mitigate the Covid-19 impact further increases the risk of a future default situation.

A rising Government debt-to-GDP ratio could exert further upward pressure on bond yields and thus likely property capitalisation rates too. At local Government and parastatal level, weak finances are expected to sustain above-inflation increases in municipal rates and utilities tariffs, those key components of operating costs.

In conclusion, we will still have to live with Covid-19 in 2021 in some form. While we do not imagine a return to hard lockdowns, in recent days we have seen a renewed small rise in new daily virus cases, and the Minister of Health will be mindful of the renewed surges in cases in the likes of the US and certain European countries.

It is not business as usual quite yet, and some form of restrictions could remain. A renewed virus surge is a risk factor, and even in the absence of lockdown rules, this could lead to a certain amount of fear of public places, which can dampen tourism, hospitality, and retail.

FNB does not to predict the virus trends, but the reality is that the vaccine is not yet here, and we have not solved the issue yet.

In short, 2021 is expected to see a return to positive economic growth, but not yet sufficient in magnitude to halt the property correction from continuing.