Commercial property’s response to long-term economic stagnation began around 2014, says FNB

The broad economic growth stagnation of the past decade brought with it a multi-year commercial property real value correcting which began around 2016. How far has this correction progressed?

2021 marked the second consecutive year of average commercial property capital value decline but when viewing inflation-adjusted average capital value, the correction has been more significant to date over the past six years.

The recent MSCI Property Digest completes the data picture for 2021, providing an update on how far certain trends have progressed.

Economic fundamentals underpinning real estate have weakened significantly since a decade ago

Commercial property has been in a longer-term ‘super-cycle’ correction phase for some years, caused by the onset of broad economic growth stagnation in South Africa following a post-Global Financial Crisis real GDP growth peak of 3.17% in 2011. From here onwards, a lack of further monetary stimulus to fuel short-term growth, along with the country’s structural issues, increasingly affected the production side of the economy, which saw annual GDP growth gradually fade.

The 2021 GDP growth ‘spike’ should be viewed merely as a normalisation of economic activity after a sharp 2020 lockdown drop, says John Loos, Property Sector Strategist at FNB Commercial Property Finance, “and not necessarily the start of any move to strong economic growth in the coming years”.

In addition, increased government borrowing over the past decade or so has led to a multi-year upward drift in government long bond yields ten years and longer, which in turn, contributed to a multi-year upward shift in average property capitalisation rates from around 2015 / 2016 onwards.

Commercial property’s ‘response’ to long-term economic stagnation began around 2014

In a lagged response to the stagnating economic growth rate from 2012 onwards, ‘All Property Total Returns’ began a broad multi-year slide from 2014 onwards, following a post-Global Financial Crisis peak in 2013. While normal capital growth was still positive, it slowed broadly from 2014 onwards.

Property income growth came under pressure following the onset of a broad rise in the ‘All Property Vacancy Rate’ from 2015 onwards, after a partial post-Global Financial Crisis recovery. From 5.2% in 2014, the ‘All Property Vacancy Rate’ rose to 8.6% and 8.4% for 2020 and 2021 respectively.

The significantly weaker long run economic growth performance, ever since the 5%+ real GDP growth rates prior to the Global Financial Crisis, means that the high real commercial property values set in those pre-Global Financial Crisis years, were no longer ‘appropriate’.

Real property values began to correct from 2016

A multi-year correction in values began in 2016. MSCI data shows a +2.3% growth rate in ‘All Property Capital Value / Square Metre’ during that year.

However, Loos says it is important to exclude the effect of general price inflation in the economy, by adjusting capital values to ‘real’ terms using a GDP inflation measure.

Nominal capital value per square metre only began to show an annual decline in 2020 and 2021, having cumulatively declined by 5.9%”, he says. “But much of a property value correction happens more gradually, with nominal value growth so slow that it does not keep up with general inflation, thereby declining in ‘real’ terms over time”.

Using inflation-adjusted capital values to assess the full extent of the correction to date, we see that the ‘All Property Capital Value / Square Metre’ has been in annual decline for six consecutive years from 2016 to 2021. And the cumulative real average value decline amounts to -26% since the peak real value reached in 2015. This has been accompanied by an inflation-adjusted decline in ‘All Property Net Operating Income’ amounting to -19.8% over the same five-year period”.