The rapid and ‘easy’ part of the economic property market ‘rebound’ following 2020’s second quarter national lockdown dip appears to be over. From here onward, it is time for the ‘hard yards’ back to being ‘fully recovered’ says John Loos, Property Strategist at FNB Commercial Property Finance.
Unlike the home buying market, which is highly interest rate sensitive, the commercial property market is more strongly influenced by trends in economic growth says Loos, and the economy to date has only ‘partly’ recovered.
“By ‘partly recovered’, we are referring to a real GDP (Gross Domestic Product) level (not growth) that remains below that of pre-lockdown levels. As at 2021’s first quarter, real GDP was still -3.2% year-on-year (y/y) down i.e., -3.2% below the level of 2020’s first quarter. While a lot better than the sharp -17.8% y/y dip in the second quarter of 2020, domestic output has not returned to pre-Covid-19 levels and the pace of quarterly improvement has slowed with the first quarter negative growth rate having only improved by 1 percentage point on the previous quarter’s -4.2%”.
The reasoning behind the last part of the recovery being slow is that a portion of the productive capacity of the economy i.e., businesses, closed their doors permanently during the lockdown-drive economic shock. Over time, others will step in to fill the gap with expansion of their own capacity or creation of new production capacity, but this takes time because many surviving businesses took a significant financial knock themselves. Business confidence is low, and caution is widespread.
“Given that the commercial property sector is strongly influenced by the economic path, it is not surprising that we have seen certain key property market-related data also seeing its pace of improvement slow after the initial sharp rebound” comments Loos.
What is worth noting in this regard has been TPN’s data relating to commercial tenants in good standing with their landlords. After a bounce-back from a low 41% in May 2020 to 60% by October 2020, the percentage of retail tenants in good standing moved more-or-less sideways to 61% by March 2021, remaining stubbornly below the 72% level of March a year ago just prior to the hard national lockdown. Office tenants showed similar lack of progress with their percentage in good standing hovering near 71% from November 2020 to March 2021, also still below the 75% pre-lockdown level.
Only industrial tenants in good standing at 69% made it back to the 69% pre-lockdown level of the three major commercial property classes.
FNB’s Property Broker Survey also points towards a significant rebound since the hard lockdown but not yet a ‘full recovery’.
Examining the 2nd quarter 2021 FNB Property Broker Survey, Loos says that brokers – as a group – do not yet imply ‘full recovery’ but they do suggest greater market stability as earlier rising vacancy rate trends may have subsided. However, brokers still point to all three major commercial property markets as being heavily oversupplied in terms of properties on the market for sale. “And” says Loos “such survey results lead us to believe that the decline in average capital values of commercial properties that started in 2020 may not quite be over”.
“The broker survey continues to point to the industrial property market being the strongest of the three major commercial property markets. However, what has changed since 2020 is that the brokers are now seeing office property as the weakest whereas retail has made something of a ‘comeback’ in 2021 to date from having been the weakest performer in 2020”.
Property market prospects
So, what then of the near-term prospects? Loos says that if one includes property classes outside of the major three commercial classes, he expects the hotel property sector to have another weak year and to underperform all three of the major property sectors. The hotel sector still battles from foreign tourist restrictions which is dependent on the progress of the Covid-19 vaccine rollouts and getting the pandemic under control, but Loos says that Covid-19 will not be the only constraint on the hotel sector going forward. Domestic households experienced a major financial knock during 2020’s recession and often non-essential spending, such as holidays, are placed on the backburner. In addition, corporates have ‘Zoomified’ many of their interactions that previously involved travel and hotel stays. Loos believes that a portion of corporate travel and hotel stays will not return.
The office property sector is expected to be the underperformer for 2021. Encouragingly, the FNB Broker Survey in the second quarter points to a perception that the rising office vacancy rate trend may stall although the buying and selling market for office space is still heavily oversupplied. With MSCI data having shown the average office vacancy rate to have reached a near 15% average last year, and likely higher by year end, Loos does not expect the market rentals in office space will end its decline just yet.
Beware the ‘Hype Cycle’
While property investors may battle to find a balanced perspective regarding office property during the remainder of 2021, Loos elaborates on a form of what Gartner and Co have termed the ‘Hype Cycle’ which refers to cycles of over-expectation followed by disillusionment when a certain technology shows great promise.
While the forced lockdown-related Work From Home (WFH) ‘experiment’ of 2020 was not technology-driven but rather pandemic-driven, the available technology that enabled the success of WFH was a big part of its success and resulting hype. This led to a huge amount of hype around the future of WFH and in many instances, perhaps an over-expectation of how quickly many more people would work from home and how rapidly office space would become obsolete.
Loos believes that the WFH hype was likely overdone, and not because it does not have a big future, but rather because some had expected too much from WFH too quickly. As a result, we are now likely to see some disillusionment to follow as many return to the office slowly but surely.
Loos believes that neither the extreme hype nor the disillusionment that follows will necessarily be in line with reality. “The reality is that many jobs cannot be WFH jobs and certain parts of jobs require face-to-face interaction. Our view since lockdown began was that the long-term trend towards greater WFH, in play for decades already as enabling technology develops, has received a boost by forcing late adopters to try WFH out but first, the level of WFH needs to drop as and when economic life normalises and then begin to resume the longer-term rising trend at what I believe will be a faster rate than the pre-lockdown rate”.
What is misunderstood about WFH is that the rising trend does not only mean a greater portion of the work force working from home full time but also the office-based population spending a greater portion of their time working remotely. This enables office space saving by companies through a move away from reserved desk space to ‘hot desking’ and ‘hotelling’.
On top of WFH, the Finance, Real Estate and Business Services (FREBS) sector shed some 7.5% of its employment in 2020. With this sector’s employment a key driver of office space demand, this alone may result in office space cutbacks by companies.
“In retail property, FNB card spend data has shown strong growth in online spend but online retail remains a minor partner in retail sales and according to the FNB Broker Survey, this has been less of a source of pressure on retail than what the brokers perceive WFH to have been on the office market” notes Loos.
Meanwhile, the industrial property market looks set to remain the relative outperformer, benefiting from greater interest in logistics required for a bigger e-commerce future to come, while also being the most affordable class of property of the major three.
Loos expects 2021 to be a year of further negative capital growth, albeit at a diminished rate in the case of industrial and retail property, with these two property classes going back into positive capital growth in 2022. Hotels and office space may take longer to return to positive capital growth, and he expects this to only happen in 2023. “While the economy is forecast to grow positively in each of FNB’s forecast period years to 2024, he warns that the property market is expected to have some ‘dampening’ pressure from a forecast rise in interest rates, starting with 50 basis points’ worth in 2022.
Coastal regions appear to be in better shape than Gauteng
Malusi Mthuli, FNB Commercial Property Finance’s KZN Regional Manager believes that the country’s coastal regions have in part ‘bucked the trend’ of severe weakness that came with the 2020 recession.
He believes that KwaZulu-Natal, being home to one of the busiest harbours, continues to offer good prospects for the industrial sector. Other than the Dube Trade Port and Cato Ridge precincts, the region lacks any expensive land release that could have a meaningful impact on industrial land supply. He acknowledges the inefficiencies in goods-handling capacity of the harbour which he believes creates a strong case for investing in logistics facilities within KwaZulu-Natal.
The scarcity of flat terrain minimizes the supply of suitable development opportunities, and all these factors play into the hands of current and prospective investors.
Mthuli believes that properties in the industrial sector of KwaZulu-Natal have been an outperformer, and this is what the FNB Property Broker Survey has pointed out in recent years. He says that the Western Cape enjoys similar attributes of supply and demand.
“KwaZulu-Natal is one of the most populous provinces in the country. It comes as no surprise that the residential sector continues to grow, underpinned by availability of cheap finance, flexibility of work that enhances semigration, and coastal lifestyle. The movement towards the north coast has unlocked new property investment opportunities, along with lending opportunities for FNB Commercial Property Finance both on the development finance and end-user perspective”.
‘Smaller towns’ in areas that are often referred to as rural ‘dorpies’ continue to surprise many through this tough economic period, often posting above average returns for investors. Retail trade in these towns remain relatively unshaken by the turmoil brought on by the pandemic.
“The catchment areas of these towns are driven by the lower end of the market, the Agricultural sector that has been rallying of late, and basic needs spending which is less affected by the changing macro environment” he concludes.
