Investors reap solid rewards from flat rentals
Flat rentals in all of the major metropolitan areas grew faster than consumer inflation over the last two years, with Port Elizabeth the top performer, notching up a growth of 6,7% p.a. This is according to the latest Rode’s Report on the SA Property Market.
Investors have reason to smile as inflation-beating flat-rental growth has also been achieved over the past five years and the past decade. Thus, investors reaped solid income growth and returns.
A less certain interest-rate outlook resulted in a marginal weakening (i.e. increase) of capitalization rates in the latter half of 2006. However, survey data for the first quarter of 2007 shows a marginal strengthening of capitalization rates. Capitalization rates are the property equivalent of the forward earnings yield of shares.
This recent strengthening was more notable and widespread in the shopping-centre and industrial markets than in the office market. The positive movement is consistent with the fact that the market not only expects the low-inflation and low interest-rate climate to persist in the medium term, but also that income streams are likely to continue growing robustly.
According to market data analysed by Rode & Associates’ team of property economists and valuers, the average leaseback escalation rate (an attempt by the market to forecast market-rental growth until the expiry of a 10-year lease) was once again around the 8% mark during the first quarter.
“Given our buoyant prospects for rental growth over the next few years, the current leaseback escalation rate may just turn out to be on the low side,” says Rode & Associates CEO Erwin Rode.
The income streams of listed property funds grew robustly over the last year, which illustrates that the strong fundamentals currently inherent in non-residential property, are filtering through to the income streams of listed funds. Income yields of listed funds have remained low, at around the 6% mark, since the beginning of the year. The two factors likely to have contributed to this are stable long-bond rates and bullish prospects for fundamentals like strong rental growth and low vacancies.
Nominal grade-A decentralised and CBD office rentals continued to march north during the first quarter of 2007. Both decentralised and CBD office rentals for grade-A office space were up by 15% on the same period last year. Building-cost inflation (as measured by the BER Building Cost Index) is expected to have grown by 10% over the same period, implying that rentals are also growing in real terms.
Manufacturing activity remained strong during the first quarter of 2007, mainly as a result of a somewhat weaker rand exchange rate and buoyant domestic demand conditions. Furthermore, purchasing managers are still optimistic about the prospects for the manufacturing industry, as indicated by the Investec Purchasing Managers index — a leading indicator of the health of the manufacturing sector — which increased in March by 3,3 points to 60,5.
The Rode team expects that the continued strength of the manufacturing sector will sustain low industrial vacancies and support the continued upswing in real industrial rentals in the coming months.
Non-residential and residential building activity grew vigorously in 2006, which in turn also resulted in strong buildingcost inflation over the year. Rode’s Report expects more of the same for 2007, with residential building activity not likely to grow as much as it did over the last couple of years, but non-residential building activity is expected to take up the slack, accelerating somewhat as the long non-residential property cycle enters its upswing phase (a process that is already at play in the industrial property market).
For the first quarter of 2007, construction-input costs (as measured by the Haylett index) are expected to have grown by 12% year-on-year. According to Medium-Term Forecasting Associates, the sharp rise in input costs was the result of higher oil prices, a weaker rand, higher material prices, and buoyant demand conditions. The BER Building Cost Index — which measures building-input costs plus the profit margins of contractors — is expected to have grown by 10% during the reporting quarter, implying that non-residential contractors’ profit margins contracted during the first quarter of this year.
“This is the implied situation when input costs (+12%) accelerate faster than contract prices (+10%)”, says Rode. “Why would contractors’ profit margins be shrinking in such a buoyant climate? The only possible explanation we can think of is that supply is catching up with demand— and that is a good sign.”
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