As discussed in a recent eProp article, R&T’s are charged at predetermined tariffs based on municipal valuations which values are currently under review across many local authorities and up for contestation by owners in some cases.

Here below eProp embellished on a couple of scenarios provided by Galetti’s Milenko Rajak to help readers grasp some of the implications for commercial/industrial property owners.

Scenario 1:  An owner occupier buys a C-grade industrial property in Wynberg, Johannesburg for R4.5 million. The property consists of a 6000m² GLA (bulk floor area), sitting on an erf/ stand measuring 7400m² in extent. The municipal valuation is R18 million and the client has been billed accordingly. In other words the market value is substantially more than the municipal value.

What can be done?

First of all, an urgent re-evaluation of the property is needed for the purposes of lodging an objection with the council. Hopefully the municipality will accept this latest valuation and reduce the R&T’s accordingly.

The owner occupier is perhaps not as concerned with the net annual Income (NAI) return of the property as an investor would be, albeit that the operating cost reduction represents a welcome saving. In the same scenario, should a ‘pure’ investor acquire the asset based upon possible rental income returns, he will substantially benefit if the R&T account is reduced.

Note however that the income capitalization or discounted cash-flow going forward could influence an upward value revision, all things being equal

Scenario 2:  The developer of a prominent industrial park in Tshwane/Pretoria buys industrial land 3 years ago and builds numerous warehousing units on it (i.e. improvements have been effected). Rentals being achieved range from R22/m² to R45/m² – significantly below the regular market price for brand new A-grade properties in the area/region.

The developer is now trying to dispose of the property asset in question which presently holds a certified market value of R100 million and which therefore assumes that the land is correctly zoned and so forth. Applying a 10% sales yield, the NAI of the property portfolio should be R10 million (based upon the property valuation of R100 million)

The R&T’s for the asset, is approximately R150 000/year (based upon the municipal valuation of the land bought 3 years ago and most likely implying that the municipality didn’t adjust for the inclusion of the warehousing units after building completion).
 
Tariffs presently being applied by the Tshwane municipality on an annual basis (for commercial and industrial properties) is 2.4% of the value of the property, and is billed on a monthly basis. If one accounts for the revised annual R&T expense of R2.4 million (being 2.4% of the property’s value), the NAI is reduced to R7.6 million, and the value of the property is now effectively R76 million (assuming the same 10% yield).
 
So, in other words, if this new tariff regime were to be taken into account, it would result in a hypothetical reduction in market value of the property portfolio to the tune of over 20%, all other things being equal.
 
In the above scenario, the developer can potentially adjust the below average rental structure and recapture some value going forward before selling. Alternatively a buyer may take a view on the below market rental and make an offer at a lower yield (higher value) knowing that there is upside.

This being said, the following has emerged, further influencing the matter:

• Although the developer was able to keep building costs relatively low, he has ignored the effect of the new R&T when signing up new tenants and he has based his acceptable rental rate on building costs alone.
• Although tenants have a clause in their lease agreements stipulating liability regarding increase in R&T, a 20% increase in overall rentals (increase in R&T of 16 times) is high. Imposing this increase on tenants could result in many unhappy tenants and possibly large defaults on rentals.
• Once the property portfolio is sold and the sale is registered in the Deeds Office, the new owner will start paying new R&T based on the sales value registered in the Deeds Office. Not accounting for these new R&T would result in a large reduction in NAI.
• The developer is incentivized to hold properties as long as possible in hope that the municipality won’t re-evaluate his properties. At the expiry of existing leases, he will have to hike rental rates to account for expected increases in R&T.

What should be considered?

When selling or renting properties, the R&T accounts should be examined and opinion should be sought on the market valuation of the properties in question as expressed on municipal accounts (R&T statements). Professional property valuers charge around R4500 for a day of work and it constitutes: going out and inspecting the property; searching the Deeds Office record of transfers of properties in the area; consultations with property brokers in the area and determining market rental rates for similar properties; typing the report.

If any discrepancies are noted, these should be brought to clients indicating possible upsides or downsides.

In conclusion, these two scenarios briefly illustrate the balancing act and interplay between market and municipal valuations, and also how ratable costs and income come into the equation. The saying ‘swings and roundabouts’ comes to mind suggesting why it is important to have correct valuations and to apply market related rentals.