South Africa’s property sector experienced another tough quarter as reflected by the further decline in the share prices of listed property funds, according to Rode’s State of the Property Market report for Q3 2023.
The prices reflect the numerous challenges faced by the industry, including load shedding, elevated interest rates, rising operating costs (including property rates and taxes) and poor municipal service delivery, not to mention the local and international economy.
Several REITs, including Growthpoint Properties, have issued grim warnings for the year ahead which explains the poor rating (elevated income yields) of listed property funds. These high yields means that REITs can only buy directly held properties at high capitalization rates (if at all), which in turn means that the net asset values (NAVs) of REITs are impaired because they are calculated as if the assets in a fund are sold individually as directly held properties. Lower NAVs mean you get a phone call from your friendly banker because your loan-to-value (LTV) ratios are now too high.
The only way to make the banker and investment analysts happy is by selling select properties which further depresses market values of directly held properties.
The office market
The office market is still in the worst position of the three major commercial property types due to its significant oversupply, with decentralized vacancy rates in South Africa still well above the long-term average of 9%.
Encouragingly, the results of Rode’s office vacancy survey show that decentralized vacancy rates of grades A+, A and B space declined further in Q3 2023 to 14.4% – better than the 16.2% in Q3 2022, supported by more workers returning to the office.
Vacancy rates of grade-A space are comparatively lower as quality space’s market rentals are low relative to replacement costs. Regionally, Cape Town saw the largest improvement over the past year in its office vacancy rate, which averaged about 12%, although it did give up some of its gains in the third quarter. Of the major cities, Johannesburg decentralized remains under the most pressure as evidenced by its vacancy rate (around 16%) remaining higher than the national average.
Rode’s nominal market rental data indicates a continued recovery from the low Covid levels, but increases are slowing and office rentals in real terms continue to look bleak. Listed property funds are also still reporting large negative rental reversion rates.
The important point remains that many companies are still working on a hybrid basis, favouring two to three days a week at an office, which means less demand for space compared to pre-Covid levels. Furthermore, office demand will not see a sustainable turnaround without much stronger economic growth.
Nationally, weighted market gross rentals for decentralized grade-A space increased by 2.8% in nominal terms in Q3 2023 compared to Q3 2022, slowing from 3.4% in Q2 2023. This takes rental growth to 2.9% over the first nine months of 2023, which shows that nominal rentals have bottomed out after falling during the Covid pandemic. But to give perspective, the third-quarter nominal rental rate on a national level was still 2.7% below 2019 levels (that is, before the pandemic). In real terms, third-quarter decentralized rentals remain in negative territory, after deducting the roughly 8% estimate of building-cost inflation (BER BCI).
Regionally, Cape Town has been the clear top performer since 2022, albeit from a low base in 2021. Nominal grade-A gross rentals in Q3 2023 increased by 12% in the decentralized nodes of the Mother City compared to a year earlier, even exceeding pre-Covid levels by 5%. In absolute terms, the Cape Town decentralised rents are also the highest of the major cities. Nominal rental growth in the decentralized nodes of the other major cities averaged between 0.5% and 2%. This implies that in real terms, only Cape Town managed to record above-inflation rental growth compared to a year ago.
The industrial market
Of the three major commercial property types, the industrial property market is still best placed, thanks to its low vacancy rates, resulting in stronger rental growth. Nominal gross market rentals for space of 500m2 grew by 3.8% in Q3 2023 compared to Q3 2022. This is slower than the 4.1% year-on-year growth recorded in Q2 2023 and was the third consecutive quarter of weaker growth. This was to be expected, given weaker economic growth and in particular the pressure on the manufacturing and retail sectors. In real terms, rentals are still declining due to high building cost inflation. Regionally, nominal rental growth was the strongest in Cape Town at 6%, albeit slower than the 7% year-on-year growth in Q2 2023. Cape Town has performed the best of the major conurbations over the past few years, with rentals up by 17% compared to the pre-pandemic 2019 levels.
Nominal rentals grew by 5% in the East Rand and the Central Witwatersrand. Both these conurbations saw an improvement in vacancy rates to just above 3% in the first nine months of 2023.
The resilience of the industrial property market is continuously surprising, which is particularly evident in its low vacancy rate of only 3.7% on a national level. Looking at the bigger picture, vacancies are lower than pre-Covid levels and below the long-term average of 4.2% since 2000. However, there is a risk of higher vacancies and lower rental growth in the short term, given the sustained level of low business confidence. Rode’s also emphasises that this is not due to excessive building activity, but rather weaker economic growth. In fact, building activity has declined so far in 2023. There is no doubt that the industrial property market will be tested again.
The residential market
The housing market continues to slow down due to lower effective demand for property as a result of the weakening economy, the high cost of living and elevated interest rates. Nominal house prices grew by 0.8% in August 2023 compared to August 2022, based on FNB data. This took house price growth to 2% in the first eight months of 2023, well below the 3.6% growth achieved in calendar year 2022.
In real terms, house prices fell by about 4% in the first eight months of 2023, after deducting the consumer inflation (CPI) rate of 6.1%. Interest rate hikes have started to affect house prices and sales activity levels more materially in 2023 and the impact is not over yet as interest rates will remain high for longer than previously thought. The reason for this prognosis is that inflation is not yet at the central bank targets, despite having declined substantially. So far in 2023, a growing number of sales have also occurred because owners are experiencing increased financial pressure.
Turning to apartments, vacancy rates on a national level averaged 6.9% in Q3 2023, unchanged from Q2 2023, but lower than 7.8% in Q2 2023, according to Rode’s residential survey data. Regionally, the Western Cape continues to stand out with its low flat vacancy rate of 2.9% in Q3 2023, albeit up slightly from 2.1% in Q2 2023.
The decline in national vacancy rates since 2021 has supported rental growth. Official data from Stats SA shows that in Q2 2023 nominal flat rentals in South Africa increased by 2% compared to a year earlier, thus continuing their sideways trend since Q4 2022. PayProp data shows that the nominal rental growth rate for housing lifted to an even higher 4.4% in Q2 2023 − the fastest growth rate since Q4 2017. However, of concern is that the number of tenants in arrears rose in Q2 2023. All in all, house prices and rentals are still declining in real terms in most parts of the country.