In a still weak, albeit improved, economy, with rising interest rates, property market fireworks do not appear to be on the cards for 2022, according to John Loos, Property Sector Strategist at FNB Commercial Property.
But there are some expected positives, notably the industrial property market, an expected turn for the better in the residential rental market, and an outperforming Western Cape region that may be experiencing a renewed surge in skilled and affluent semigrants from elsewhere.
Loos lists ten key themes that FNB believes will be worth looking out for this year:
- A rising trend in the ‘All Property Vacancy Rate’ is expected to continue in 2022, moving into double-digits
The MSCI All Commercial Property Vacancy Rate has been on a broad multi-year rising trend, from a low of 4.3% as at H2 of 2015 to 9.7% by H1 2021. FNB anticipates this rate to move into double-digit territory in 2022, if it hasn’t already during H2 2021. However, economy-wide production levels may be insufficient to fuel enough demand for commercial space to ‘eat into’ the mounting oversupply.
While FNB projects Real GDP, the measure of the economy-wide production or output, to return to pre-pandemic levels, the 2019 GDP level was insufficient to halt the rising vacancy trend.
After a sharp -6.4% in real GDP in 2020, the level of economy wide output is believed to have partially recovered to pre-pandemic levels with a +4.7% growth prediction for 2021 – insufficient to fully revive the output level. Besides mild lockdown restrictions having remained in place during 2021, a portion of business did not survive 2020, implying a reduction in the economy’s output capability with the expectation that it would take some time before GDP could fully ‘normalize’.
The key driver of the rise of the ‘All Property Vacancy Rate’ is expected to be underperforming office market with a further rise in the national ‘All Property Vacancy Rate’ expected to sustain downward pressure on real rentals and real net operating income.
2. Rising interest rates are expected to sustain the multi-year broad rising trend in capitalisation rates
The global economy’s recovery post 2020’s hard lockdown-related recession, coupled with major global supply chain disruptions to the supply side of the economy, has unleased a surge in inflationary pressures.
Domestically, the Consumer Price Index (CPI) inflation rate rose throughout 2021, from 2.9% year-on-year as at February to 5.5% by November, with petrol and food prices key influencing factors.
This brought the CPI inflation rate near to the 3 – 6% upper target limit of SARB, which responded by raising interest rates by 25 basis points in November with three additional 25 basis point interest rate hikes expected during 2022, taking the prime rate from its current 7.25% level to 8% by yearend.
The anticipation of a further rise in the Government debt-to-GDP ratio, with Government finance under pressure, along with short-term interest rate hiking, is expected to exert upward pressure on long bond yields and therefore property capitalization rates in 2022, with cap rates a source of downward pressure on real commercial property values.
From a decade low monthly average of 6.9% in May 2013, the monthly average long bond yield ended last year 3 percentage points higher at 9.9% and the broad rising trend is expected to continue this year.
3. Average capital value per square metre on commercial property is expected to halt its decline in nominal terms in 2022, but not in ‘real’ inflation-adjusted terms
Despite the economy remaining weak, and only expected to return to the 2019 level of real GDP this year, three years later, the economy will likely significantly improve from the hard lockdown during 2020. FNB expects that ‘nominal’ average capital values on commercial property will at least halt its decline of the recent years in 2022, moving back into low single-digit positive territory.
However, rising cap rates and weak net operating income growth is expected to keep average capital values in ‘real’ declining territory i.e., the likely low capital growth is not expected to keep pace with the general price inflation rate in the economy.
The multi-year correction in property values, in effect, is expected to continue this year, albeit at a slower pace and in real terms only.
How far are we into the multi-year correction in real property values?
Since H2 2018, average capital value per square metre has declined by -9.5% as at H1 2021, according to MSCI data but, 2016 was the year in which the correction really began, in a lagged response to broadly stagnating economic growth since 2012 or so. While nominal valuations were not yet declining significantly until much later, 9 out of 11 semesters from 2016 to H1 2021 have shown real (GDP inflation-adjusted) declines in average values when compared with the preceding semester. While actual valuations dropped far less, in real terms, the cumulative decline in the MSCI All Property Average Capital Value has been a significant -29% from H1 2016 to H1 2021.
4. The hotel property market is expected to improve this year, but it will remain behind the ‘Big 3’ commercial property classes
Three major challenges face the hotel property class; firstly, a large portion of demand for hotel rooms is non-essential in nature, and many businesses and households financially pressured in the aftermath of the major 2020 recession, will continue to put travel and hotel stays on the backburner.
Secondly, given the successful ‘Zoomification’ of most business interactions during the lockdowns, a portion of business travel that used to take place is unlikely to return.
Thirdly, South Africa has been plagued by limitations on foreign travellers travelling to the country. The vaccine rollout is key in improving this situation, but the Sub-Saharan African region is reportedly behind with this rollout.
All three of these challenges are expected to be, in part, alleviated during 2022, enabling an improved market, but insufficient to end its underperformance in relation to the ‘Big 3’ commercial property classes. By October 2021, the average hotel occupancy rate had risen to only 31.6% from 18.8% in October 2020, which was still far below the 52.8% of October 2019, while total hotel income for October 2021 was still 32.9% down when compared to October 2019.
5. More employees are expected to work from the office in 2022 but not at levels sufficient to end the rising office vacancy trend
The office market is expected to remain the underperformer this year, with its already high average national vacancy rate of 17.9% (according to MSCI data) as at H1 2021 and it is expected to rise further.
This major class is expected to see its national average vacancy rate continue to climb in 2022, as many companies revise their office space needs even more. The work-from-home surge is a key dampener of demand for office space but as lockdowns ease and economic activity trends towards ‘normal’, more employees will go back to the office. However, FNB believes that the level of full-time office working won’t go back to the same levels pre-Covid-19 and as technology continues to improve, so the multi-decade trend towards great remote work levels will resume.
People often overlook two other sources of pressure on the demand for office space; the first is the normal recession effect, which caused a major drop in employment numbers in the office-bound sectors of the economy, meaning that, without any increase in remote work, there are less employees in these services sectors, which would normally imply less office space required.
In addition, the trend towards improved utilisation of desk space seems to have picked up speed of late, with ‘hotelling’ of desk space increasing in popularity, something Firstrand has recently implemented with employees either booking a desk for a day or they do not have one. This sharing of desk space will further reduce the need in coming years for office space.
Partly offsetting the above-mentioned office space ‘demand dampeners’ is social distancing measures in the office, which often requires companies to have lower density work spaces but, FNB believes that this only a partial offset of the above, leaving the office market under pressure in 2022 with its average vacancy rate rising further.
6. Retail was better in 2021 than in 2020, but further improvement are likely to be harder going into 2022 with households financially constrained
After underperforming the office market in the 2020 lockdown year, retail property made something of a comeback in 2021, and its total returns last year likely outperformed those of office property but underperformed those of industrial property. Sandwiched in between the industrial and office markets are where FNB expects retail property returns to stay in 2022.
Real household disposable income is projected to grow further, but at a very low rate of +0.2% in 2022, following a +2.8% growth rate in 2021. Real disposable income growth is expected to be constrained by weak employment growth with companies attempting to use labour productivity improvement instead of employing, as they rebuild balance sheets.
Slightly higher average consumer inflation in 2022, compared with 2021, is expected, and forecast hikes in interest rates on outstanding debt would eat into disposable income even further. On top of this, the long-term rising trend in the effective tax rate on households is expected to continue, with adjustments for wage inflation-related tax bracket creep being partial.
Retail centres are expected to focus more on high frequency essentials, and less on luxuries to outperform, implying that total returns on smaller sized convenience, neighbourhood, and community retail centres, are likely to outperform the larger regional centre categories.
7. The industrial property market to remain the outperformer of the three major commercial property classes
The most affordable of the three, and arguably the most adaptable, the industrial property market has a relative advantage when the economy is under pressure. It also appears set to benefit in coming years from the increased online retail focus. However, FNB questions how far this outperformance can extend, as manufacturing production is mediocre at best, and economy-wide inventory levels have declined significantly in recent years.
Nevertheless, the FNB Commercial Property Broker Survey of recent quarters have shown the industrial market to have been the strongest throughout 2021.
8. The residential rental market is expected to see better times
Having experienced a weak period in recent years, the residential rental market is expected to see some strengthening in 2022. It is already evident from TPN tenant data that the percentage of tenants in good standing with their landlords, regarding rental payments, has recovered markedly following the 2020 lockdown dip. In addition, we have started to see signs that the national average rental vacancy rate has possibly peaked, and it is beginning to move lower. TPN’s national average vacancy estimate has declined from 13.31% in Q1 2021 to 10.66% by Q3, and average rental inflation increased mildly to +0.4% year-on-year in Q4 after having dipped into moderate negative territory in prior quarters.
A decline in vacancies would provide some mild support for something of a rental inflation recovery, of which early hints have already been seen.
A mild recovery in the residential rental market in 2022 is expected because of further moderate interest rate hiking which typically curbs the first-time buyer rush that interest rate cutting brought on from 2020, that rate cut-drive buyer demand surge having helped to leave a ‘gaping hole’ in the rental market. And, with a greater portion of tenants’ income restored, new household formation in the rental market may be ready to pick up some speed.
9. The residential development market is expected to peak
Despite the residential rental market expected to pick up moderately, it will likely still be well-supplied for 2022. In addition, expected rising interest rates should likely cool home buyer demand, and FNB expects to see the number of residential unit plans passed peaking in the near term in 2022, with residential completions to follow suit with a mild lag. This year may see the most recent ‘mini-surge’ in residential building activity peak.
10. The Western Cape is expected to outperform economically and property-wise, as semigrants continue to flock to the province
This expectation is based on the belief that the province’s ability to attract semigrants skills and purchasing power, crucial for economic growth, has recently been enhanced.
The Western Cape has been the most popular semigration destination for many years, due to the perception that the province boasts a great lifestyle couple with significant economic opportunity. It has also been seen to be a region where provincial and local government is relatively well-run and as time has passed, communication and information technology has enabled businesses and individuals to be more removed from the major economic hub of Gauteng.
In 2021, the unrest and looting in KZN and Gauteng may have further enhanced the relative appeal of living and doing business in the Western Cape, which largely escaped this. In addition, the City of Cape Town is the only one of the major six metros that has emerged from the recent local government elections with its ruling party having a clear majority, and thus free of the uncertainty of coalition politics.