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Rental markets continue to wane in spite of SA’s emergence from the recession


In spite of the technical emergence of the economy out of the recession, the latest Rode’s Report on the Property Market (quarter 2009:4) reveals that rental markets in particular continue to feel the pinch of weak economic conditions across the commercial, industrial and residential arenas.

On the office front, Johannesburg and Cape Town decentralized have seen yearly growth in rental markets wane to below 2%. However, in Durban decentralized (+9%) and Pretoria decentralized (+12%) the market has still shown surprising robustness.

The light on the horizon – at least for this sector of the industry – says property economist Erwin Rode, is that over the same period building-cost inflation is expected to have contracted by about 2%. This implies real rental growth – on the whole – in all of the decentralized areas, he says. The decline in building costs reflects the dire state of the building-construction industry.

However, the effects of softer economic activity on the demand for industrial space – and consequently its effect on market rentals – are also becoming strikingly evident. On the Rode scale of 0 to 9, industrial vacancies in the major industrial conurbations increased to between 2 and 3,5 during the third quarter, in turn equating to percentage vacancies of roughly between 3,5% and 8,2%. While the best rental growth was recorded in the East Rand (5%); the Central Witwatersrand recorded a meagre 2% and the Cape Peninsula 1%. However in certain areas, market rentals were even lower than a year ago – namely Durban (-5%) and the West Rand (-16%).

Commenting on the effects these results are having on capitalization rates, Rode notes: ‘The principal risk to the outlook for capitalization rates remains the scaled-down expectations regarding the direction of real rentals. This potentially could see property investors requiring higher income returns from property because of deflated capital-return prospects, thereby suppressing values.’

For the time being, capitalization rates for non-residential property types kept on moving sideways from their previous-quarter levels. ‘This means market values in the suburbs are stabilizing,’ says Rode. The exceptions are office buildings in the country’s CBDs, where capitalization rates are spiking. The rising capitalization rates in the CBDs illustrate the principle that during tough times the second-best (measured by node or quality of building) tend to fare the worst.

Flat rentals also continued to show lacklustre growth. Durban managed what could be called the ‘best’ yearly growth at only 5%, while rentals in Johannesburg and Cape Town were up by a meagre 2%. For Pretoria and Port Elizabeth, rentals remained roughly at the same level of a year ago. These low rental-growth rates also applied to house rentals. ‘As residential rentals have a heavy weighting of 16,4% in the Consumer Price Index, these figures naturally are good news for inflation, as measured by the CPI,’ says Rode.

The outlook for building activity also looks bleak, as building-input costs and tender prices continue to decelerate. In the third quarter of 2009, real gross fixed capital formation in residential buildings contracted by 8% (i.e. 8% fewer ‘bricks’ were put in place); while growth in non-residential building activity decelerated to 7% ─ its lowest yearly growth rate in nearly four years.

Notes Rode: ‘In fact, contractors are currently being forced to trim their profit margins so much that the BER BCI is expected to have contracted by 2% in the third quarter of 2009, while the demand for labour materials, machinery and equipment has also faded to such an extent that building-input prices are expected to have contracted by about 1%.’

There is some good news, however, with housing prices seemingly having bottomed out in April.

But it is, according to Rode, too early to celebrate as it remains highly unlikely that the recovery in nominal house prices will result in a change in the direction of real house prices any time soon. Reasons for this are:

• The grim prospects for the country’s finances (which will put pressure on taxes)
• Rising unemployment
• House prices are in real terms very high
• Households’ high debt levels
• Constraints on economic growth through the electricity debacle and the gloomy outlook for the world economy.

Please note: Capitalization rates are the property equivalent of the forward earnings yield of equity. When they rise, market values tend to drop, and vice versa.