SA’s retail property market is on a path to mediocre recovery

The South African retail property market appears to be the ‘middle of the road’ performer, sandwiched in between the underperforming office property market and the outperforming industrial property market.

When looking at the retail property market’s prospects, John Loos, Property Sector Strategist at FNB Commercial Property, points out that it remains a relatively expensive property class by historic standards. Since the mid-1990s, it has seen very strong rental inflation, operating cost inflation and capital growth.

Using MSCI annual data, adjusting for general inflation in the economy to get ‘real values’, real retail property net operating income (inflation adjusted using GDP inflation) has fallen by -20.9% from the peak 2015 level to 2020, while real capital value per square metre had fallen -18.8% over the same period. However, these real values in 2020 were still a massive 60.2% and 72.3% up respectively on 1995 levels.

The retail property market’s meteoric rise in real rentals, income, and values, occurred during the consumer boom years prior to the Global Financial Crisis recession of 2008/2009. Interest rates had been reduced sharply from the late 1990s with consumers, far less indebted, going on a credit-driven spending spree, and economic growth was 5%+ or so in the years preceding the Global Financial Crisis.

The pre-Global Financial Crisis economic and consumer environment justified a sharp rise in real retail property rentals and values. However, after a post-Global Financial Crisis decade of economic growth stagnation and gradually rising financial pressure on consumers, the property class was due for a significant correction in its values, to better reflect economic fundamentals.

Since 2016 or so, these values started to broadly correct with the additional challenge of growing online retail.

After a dramatic retail lockdown around Q2 2022, the retail property market’s performance was expected to bounce back significantly off a low base but when looking at the bigger, long-term picture, the question remains: bounce back to what?

Almost all important economic and other data related to the retail property market points to a far better situation in 2021 when compared to 2020 but the myriad of structural challenges that our economy faces suggests that we are returning to ‘mediocrity’ at best.

TPN tenant payment performance data shows that retail property tenants were worse affected than the office and industrial tenant populations during the 2020 hard lockdowns and despite having recovered to where 66% of tenants were in good standing with landlords by July 2021, a massive improvement from 41% in May 2020, the level remained well below the 71% measured prior to lockdowns during March 2020. In addition, by October 2021, the tenants in good standing percentage had slightly receded to 64%, suggesting that the last part of full recovery may be the toughest with the percentage remaining below the industrial property market’s 71% and the office market’s 70%.

The economy in 2022 is expected to reach ‘fully recovered’ status i.e., to return to 2019 levels of real GDP and if the vaccine rollout continues, with the threat of the pandemic receding, further ‘normalisation in economic activity is expected which will have positive spin-offs for physical retail, especially the entertainment and restaurant tenants.

However, consumer constraints are expected to remain significant with real GDP growth projected to recede during 2022 from 4.8% in 2021 to 2.2%. Real household disposable income growth is forecast to be even slower at 0.2, after an estimated 2.8% last year, constrained by weak employment growth, rising interest rates, and rising effective personal tax rates.

Ongoing financial constraints still point to non-essentials underperforming essentials with smaller retail centres focusing on high frequency essentials likely to continue to outperform the larger regionals.

The improved GDP since 2020 is also expected to lead to the rising vacancy rate trend across retail property to peak in 2022, but this rate may still be too high to alleviate significant pressure on real rentals just yet.

Rising interest rates locally and internationally, coupled with an expected further rise in levels of government indebtedness in South Africa, leads to the belief that government long bonds (a key driver of the local bond market) will continue a multi-year broad drift higher, which in turn will drive capitalization rates on property too.

FNB anticipates a mild improvement in tenant performance during 2022, as the 2020 recession effects fade, and positive property income growth is achieved. This in turn leads to an expectation of very low positive capital growth, in order of 1% this year, which would be a big improvement on the -10.3% in 2020 and the expected -4% in 2021 but it would translate into ongoing decline in values in ‘real’ terms when adjusting for general inflation in the economy.

Given what has been said about the retail property market having become a very expensive property class, further gradual real correction is expected to align the market’s values with weak domestic long-term economic fundamentals.

In a nutshell for 2022, a significantly improved retail property market performance from the past two years is expected but, a mediocre one with ongoing gradual real value correction, influenced by an economy vastly different from the pre-2008 boom period.

While structural changes in the form of online retail and greater levels of working-from-home have significant implications for logistics, retail, and the office markets, it seems that online retail is slowly creeping up on retail property compared to the jump in the forced work-from-home movement’s major shock to the office property market.