It is too early to say how Russia’s invasion of Ukraine will affect South Africa’s economy and the property market but, there are some potential obvious concerns, says John Loos, Property Sector Strategist at FNB Commercial Property Finance.
The conflict is likely to add to already troublesome global inflationary pressures, most notably energy prices. Potential energy supply disruptions partly due to sanctions and boycotts against Russia, a key oil and gas producer, have seen energy prices rising significantly.
“On Friday, the 4th of March 2022, at the time of writing, the Brent Crude spot price was near $115 per barrel, 17% higher than the 23rd of February 2022, the day before the invasion began”, he says. “This adds to already-mounting energy price inflation pressures, the recent Brent Crude price levels being approximately 124% above the end of 2020’s level, and in South Africa, petrol prices have already been skyrocketing. The Ukraine invasion effect looks likely to add to this fuel price inflation. Coupled with this, the escalation of sanctions and boycotts, some allies, and potential retaliation, can further exacerbate broader supply chain disruptions globally, which can be inflationary”.
Domestic Agricultural Economist Wandile Sihlobo also sees potential food price inflation, with Ukraine being a key agriculture producer. He points to maize, wheat, soy bean, and sunflower oil prices being significantly higher compared to a year ago.
While the inflation in certain commodity prices in agriculture and mining, notably gold as a safe haven investment, can be beneficial for domestic agriculture producers and mining companies, a Ukraine inflationary effect on local food and petrol prices, as well as a possibly widespread inflation impact from general pressures, is likely a negative, not only eating into consumer incomes but also because of greater upside risk to interest rates, given SARB’s inflation target.
The war impact, especially via upward pressure on global energy prices, can also be a global economy-negative and a domestic economy downside risk mainly via South Africa’s trade, mining, and manufacturing sectors.
While upside inflation, an upside interest rate risk, and downward economic growth risk are the basic macroeconomic threats that could emanate from the war, what is the potential impact for the domestic commercial property sector?
Capitalisation (cap) rates
Given a partial link between short-term interest rate and long bond yields on one hand and property cap rates on the other, some negativity around inflation prospects led to some sell-off of South African government bonds with the average yield for 10-year bonds having risen from 9.26% as at the 25th of February 2022 to 9.665% as at Friday, the 4th of March 2022.
While this is not a major sell-off in bonds to date, it does suggest that the crisis is fueling heightened inflation and interest rate fears which would likely exert upward pressure on locally property cap rates, negatively affecting property valuations.
Following recent years of rising average vacancy rates in industrial, retail, and office, the latest FNB Property Broker surveys in late 2021 pointed towards a possible stabilisation in retail and office vacancy rates and a decline in industrial vacancy rates.
South Africa’s economic situation remains fragile and any major global recessionary impact on the domestic economy could see vacancy rates rising once more. While industrial property may weather an economic storm, the fragile retail and office markets, challenged by increasing online retail and greater remote working respectively, could easily see renewed weakness that could return these sectors to rising vacancy rates and further downward pressure on rentals.
The industrial property market’s link to the global economy is strong via warehousing and logistics space used for imports and exports, as well as the local manufacturing sector’s strong trade links with the rest of the world.
However, retail’s links are more indirect with rand weakness and higher global inflation partially bringing imported inflation into consumer goods prices.
The office market is arguably the least directly exposed to the potential global economic impact from the Ukraine War, although it does house certain tenants who trade internationally. But its potential impact is more indirect, via the slowing economy impacting the number of office worker jobs, in turn exerting pressure on office space demand. Higher interest rates, too, would exert additional pressure on both the landlord and tenant population.
The Ukraine conflict looks to be a negative pressure on property valuations too with the risks of additional upward pressure on cap rates via long and short-term interest rates, and on vacancy rates via economic impact which may translate into downward pressure on rentals.
The residential rental market
This one is tough to call says Loos. “Mild additional upward pressure on interest, over and above what would have been the case excluding the war, could see additional impetus provided to the expected rental market recovery. We have expected that the rental market will strengthen as interest rates rise, with the economy and tenant payment performance both recovering following the hard lockdowns, and a greater group of would-be home buyers choosing to remain in the rental market for longer”.
“But for this to continue, the negative economic impact of rising interest rates, and any additional Ukraine impact, must be mild at worst. Too big an inflationary and interest rate impact exerts financial pressure on tenants, and then all bets of recovery in this market are off. It’s a fine balance”.
In short, the Ukraine war impact remains uncertain, with much depending on how long it continues, the final outcome, and what happens in terms of global sanctions and boycotts.
But the likely impact will be inflationary of some magnitude, which in turn heightens upside risk to both short and long-term interest rates, along with potential downward pressure on global economic growth.
For property, the main potential impact points are via upward pressure on cap rates, upward pressure on vacancy rates, downward pressure on rentals and thus property incomes, as well as possible additional upward pressure on operating costs.
For the residential rental market, the recovery can continue should the war impact be mild at worst, but this market’s tenant population cannot handle too big an economic impact before tenant rental payment performance starts to suffer again.