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Latest Rode’s Report shows commercial and industrial markets still strong


In the midst of all the doom and gloom in the South African residential property market, commercial and industrial markets are still booming according to the latest issue of the Rode’s Report on the South African Property Market.

Says property economist Erwin Rode: “Industrial rentals in particular are sustaining the robust growth we saw during the first quarter of 2008. For example, nominal rentals for prime industrial space in the Central Witwatersrand have shown a particularly impressive year-on-year growth of 27%.”

According to the Report, other industrial nodes that have performed well are the Cape Peninsula (24% growth) Durban (22% growth) and Port Elizabeth (14% growth). Comments Rode: “This is particularly impressive when one takes into account building-cost inflation: even though this is expected to have grown by 20% on a year ago, we nevertheless still saw real-rental growth in all of these industrial areas, barring Port Elizabeth.”

Although it was expected to see a slow-down in the building industry, the latest Rode’s Report shows that non-residential building activity, as represented by real gross fixed capital formation (GFCF) was up by an impressive 14% in the final quarter of 2007, while residential GFCF, which has been decelerating since the end of 2005, grew by 6.4%. But, notes Rode with caution: “It still remains to be seen what effect the energy crisis and in particular Eskom’s moratorium on new developments could have on the industry.”

According to the Report, office rentals in certain areas have not fared too badly either, with rentals in Johannesburg decentralized up by 16%, and in Pretoria and Cape Town decentralized up by 15%. However, notes Rode: “Once you’ve taken 20% building-cost inflation into account, the probability is that, in spite of their growth, none of these decentralized office nodes will show positive real growth over the past year.”

Also faring well were flat rentals in Johannesburg metro where nominal rentals ended year-on-year on an average of 26% higher – far exceeding the growth rate in consumer inflation of 9%. Unfortunately, figures in other metros did not fare as well, the lowest being 8% achieved collectively by Pretoria and Cape Town.

On the listed property front, the Report indicates that investors are now demanding higher income returns, which in turn is leading to price declines in the market. Since the end of last year, historic income yields on listed property have weakened (increased) from roughly 6% to above 8% during May 2008, resulting in a price growth averaging -6%, year-on-year, during the first quarter of 2008. Over the same period, 10-year bond yields moved up from 8% to almost 10%.

Regarding capitalization (“cap”) rates for prime office property, the Report also reveals that this sector of the market is still showing some strength in the first quarter of 2008, although cap rates on industrial leasebacks and shopping centres seem to be feeling the pinch. Says Rode: “The non-residential market has been a sellers’ market since 2003, but under the current circumstances, it could now turn to being a buyers’ one. However, the prospects of strong rental growth could still provide a negotiating lifeline for sellers.”

The Report also indicated that, for the first quarter of 2008, property investors were requiring a total return (income return plus capital appreciation) of roughly 15% to 15,5%. “One of the ways of determining the value of an income-producing property is by discounting the expected future income stream by a required hurdle (opportunity-cost) rate,” explains Rode. “Thus, the sharp deceleration (or strengthening) in hurdle rates since 2000 serves as an indication of how favourable investor sentiment was towards non-residential properties.”

This, continues Rode, was not only as a result of the strong business-cycle upswing in the South African economy at the time, but also the structurally low, stable inflation and interest rates (and the promise of lower, risk-free opportunity costs). In the current climate, however, investors might soon require higher minimum income and total returns in order to induce them to acquire directly-held property.

There is also no relief in sight yet for the housing market: in May 2008, national house prices in the middle segment of the market revealed only 4% year-on-year growth. More revealing is the fact that house prices were 0,1% lower in May than a month previously, and according to economist John Lottering of Rode & Associates: “We have yet to see the impact of the interest-rate hikes experienced not only in April of this year, but those as far back as October and December 2007, as the full impact of these hikes is only truly revealed in the market up to three quarters of a year beyond their occurrence. We are of the opinion that by the end of this year average prices could contract by up to 10% compared to December 2007.”

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