SAPOA’s Western Cape chapter recently held a post-2023 Budget breakfast with Professor Brian Kantor to unpack its possible implications on the real estate industry.
An economist and the former Chief Investment Strategist at Investec Wealth and Investments, Professor Kantor has been involved in property for many years and he believes that the Budget is of particular importance to the real estate industry due to its impact on interest rates, capitalisation rates and the subsequent value of buildings.
“The lower the interest rates, the lower the cost of capital and the lower the required returns,” he said. “The real estate industry has been burdened in the way that South Africa has been burdened, with very high interest rates – 4% or 5% more than expected inflation.”
“How much inflation are you anticipating when you are signing contracts? 4%, 5%? The government believes it to be about 5% and long-term interest rates are around 11%. If you add a risk premium to 11%, you easily come up with 15%. Subtract inflation, and you are left with a required return – real of inflation – of 10%. This is a high hurdle for the real estate industry over which to leap.”
Why are interest rates so high and what does the Budget have to do with it?
According to Professor Kantor, the government’s Budget and taxing has a clear impact on the real economy i.e., fixed growth. Expectations of growth influence interest rates and the more growth, the easier it is to collect. Growth the size of an economy establishes a country’s tax base. If there is no growth, with continued pressure on government spending, there will be strain, which was evident in the Budget.
It boils down to the ability to rein in revenue and repay the obligations on your debt as government which really determines the cost of your debt.
“Interest rates are too high,” he said. “To compensate lenders onshore and offshore, with the risk that South Africa will default on its debt, portrays the probability that we won’t be able to meet our obligations and to pay interest while repaying our debt. South Africa’s interest burden is huge, exaggerated by the pandemic which has not only had a terrible impact on the real estate industry, but on government finances, where revenue has collapsed, and debt has had to compensate for the lack of revenue. Interest has built up, currently at around R340 billion a year equivalent to around 18% of all government spending which is up from around the 8% just before the Global Financial Crisis – this equates to 8% of all government expenditure.”
On the announcement of the Budget, interest rates came down quite strongly he said but on the minute of the Budget, they fell, recovered somewhat, but eventually gave up most of their earnings.
“While we want to get South Africa right, and what happens with lower interest rates, a lower risk premium and with less uncertainty about our ability to pay our way, this year’s Budget, as with the last few Budgets, have contributed to this,” he said. “Because while me may spend badly, we are however collecting tax. We are getting closer to largely spending our funding in sustainable ways.”
The never-ending story of load shedding
We cannot grow an economy without keeping the lights on however, Professor Kantor believes that there is a bit of light at the end of South Africa’s tunnel.
“Eskom is a very important development because it has told government (and the ANC) that if they do not get it right, they may lose votes. They are aware that their electoral prospects in fourteen months’ time are dependent on load shedding.”
“South Africa is a democracy and Eskom’s performance has political concerns, supported by an ideology that was inherited. The practical political implications of a conspicuous failure of state government and state management has let us down.”
“I believe that the story of Eskom was never a going concern. It could not pay its interest on its debt. Government is its only shareholder, and it has not bailed out Eskom, giving them nothing to recover their debts but there is more to this story in the Budget – Eskom needs to get out of the generation business and to lease their generating capacity.”
Professor Kantor posed the question: “Is there a difference between a thirty-year-old lease and permanent ownership in the real estate industry?” His answer is no. “The project has to pay for itself in twenty years to avoid terms like ‘privatisation. However, if you are running a private business, you are incentivised by the bottom line. You get paid more if the business is more profitable. The best companies to work for, perform the best.”
“It is interesting to see how the private sector, which includes the real estate industry, compensates for the failure of the state, undermining the argument of the state.”
He closed off by saying that we are trying to get it all right, with a genuine commitment to reversing the troubling trends that South Africa is faced with however, he does not believe that we can hope for much of a change in the behaviour – “We need to get the state out of our lives.”
“On the other hand, Cape Town works well. It is an example of satisfactory government. The beauty of governing the city is that the rate income is rising all the time as well as the tariffs because the house prices are rising, unlike the rest of the country, because rates payers receive the services. This is not an impossible task but who is going to lead the way forward?”
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