Slower it all goes, but can retail property be the downturn “outperformer” again”?

Posted On Tuesday, 15 November 2016 09:55 Published by
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The Commercial Property Market has been seeing its average capital growth slowing in recent times, driven by economic growth weakness and interest rate hiking of recent years.

John_LoosFNB

We project further slowing in 2017 in all 3 major Commercial Property Segments, i.e. Retail, Industrial and Office.

Property, but with Retail Property, as has been typical in prior periods of weakness, being the “relative outperformer”. Such a “relative outperformance” expectation is not without its risks though.

KEY POINTS

 The signs of slowing in the Commercial Property Sector have been emerging for some time. From a multi-year high of 10% year-on-year in the 1st half of 2013, Bi-Annual IPD Commercial Property Data showed a gradual slowdown in All Property Average Capital Growth Per Square Metre to 3.5% by the 1st half of 2016. It must be emphasized that such estimates of capital growth are net of capital expenditure on properties though.

 The slowing in capital growth was broad-based according to IPD biannual data, extending across all 3 of the major Commercial Property Sub-Segments. While all 3 segments showed slowing capital growth in the 1st half of 2016, Retail Property was still holding up best with growth of 5.3% year-on-year, Industrial and Warehouse Property in the middle with 3.5%, and Office Property the weakest with a negative rate of -0.9%.

 Recent SARB (Reserve Bank) data, too, has pointed to weakening in the Commercial Property Market, with its estimate for the value of New Commercial Property Mortgage Loans Granted declining by -16.44% year-onyear in the 2nd quarter of 2016, the 2nd successive quarter of year-on-year decline..

 Our econometric model-driven forecasts are for Retail Property Capital Growth to slow to 3.9% in 2017, which is low but positive. However, as was typical in the last 2 periods of market weakness, we project some capital depreciation (remembering that this data is net of capital expenditure) for both the Industrial and Office Property Sectors.

 But while we forecast Retail Property getting through the slow property period as the “outperformer” relative to the other 2 sectors, there are some risks to such a projection. We say this, firstly, because Retail

Property has run the hardest of all of the major property segments over the past 2 decades. Since 1995, Retail Property’s Capital Value per Square Metre (inclusive of Capex), according to IPD annual stats, has risen by a massive 770.7%. By comparison, Industrial Space has inflated by a lesser 466.7% and Office Space by 464.5%. In addition, there is the potential retail mall challenge from online shopping, something of an unknown.

Signs of slowing in the Commercial Property Sector have been evident for some time

The signs of slowing in the Commercial Property Sector have been emerging for some time. From a multi-year high of 10% year-on-year in the 1st half of 2013, Bi-Annual IPD Commercial Property Data showed a gradual slowdown in All Property Average Capital Growth per Square Metre to 3.5% by the 1st half of 2016. It must be emphasized that such estimates of capital growth are net of capital expenditure on properties.

The slowing in capital growth was broad-based, extending across all 3 of the major Commercial Property Sub-Segments. While all 3 segments showed slowing capital growth in the 1st half of 2016, Retail Property was still holding up best with growth of 5.3% year-on-year, Industrial and Warehouse Property in the middle with 3.5%, and Office Property the weakest with a negative rate of -0.9%.

Recent SARB (Reserve Bank) data, too, has pointed to weakening in the Commercial Property Market, with its estimate for the value of New Commercial Property Mortgage Loans Granted declining by -16.44% year-on-year in the 2nd quarter of 2016, the 2nd successive quarter of year-on-year decline.

 A slowing in the Commercial Property Sector is easily explained by the past few years of economic weakening and mild interest rate hiking

The slowing in various forms of growth in the Commercial Property Market of late is explained in part by a broad economic growth stagnation which started back around 2012. Following the massive global and local monetary and fiscal stimulus packages which lifted the economy out of its 2008/9 recession, South Africa’s GDP growth accelerated to peak at 3.3% in 2011. Since then, however, it has tapered all the way to an average of 0.3% yearon-year for the 1st half of 2016, the result of South Africa’s myriad of structural constraints, a global commodity price slump and a domestic drought to add to the pressures.

In addition, short term interest rates have risen by 200 basis points since January 2014, while Government Long Bond Yields have risen from a 6.9% average for May 2013 to 8.7% by November 2016.

Weakened growth, implying the prospect of higher vacancy rates, along with increased interest rates, have conspired to lift capitalization (cap) rates off their best levels.

 FNB forecasts are for slight improvement in overall economic conditions in 2017, but perhaps not yet enough to turn the Commercial Property Sector stronger just yet

We do believe that interest rate hiking may be over for the time being. As the drought conditions look set to ease, domestic food prices could come off quite strongly, helping CPI inflation back into its target 3-6% range. That would end the need for further rate hiking for the time being, provided the Rand behaves reasonably well.

Economic growth could also be given a mild boost to around 1% in 2017, as Agriculture picks up after the drought and slightly higher commodity prices begin to provide some additional support to especially the mining sector.

But slightly improved economic conditions may not yet turn the Commercial Property Sector stronger as early as next year.

This is due to certain leads and lags built into the economic cycle. “Mainstream” Retail Sales have seen growth beginning to slow more sharply only in recent months. This Retail, most relevant to shopping centre space demand, lags the cycle a little, unlike the more ‘leading” Vehicle Retail component. We thus project further annual slowdown in real retail sales growth from a forecast 2.1% for 2016 to 0.7% in 2017, which could be expected to raise the average Retail Property Vacancy rate.

Our 1% overall economic growth forecast is also not expected to be sufficient just yet to lift Manufacturing Capacity Utilisation or economy-wide inventory growth significantly, which would be required to boost Industrial and Warehouse Space demand.

And with regard to growth in demand for Office Space, the fortunes of the Finance, Real estate and Business Services Sector are crucial, though not its GDP growth but rather its employment growth. This sector lagged the recovery post-2009 and has also lagged in the economic slowdown since 2011. Unfortunately, therefore, it is expected that it will weaken further before turning the corner, and that during the forecast period there could be some job loss that could slow the demand for office space.

 2017 expected to be another year of slowing in capital growth (net of capital expenditure)

Therefore, despite some expected turn in fortunes for the overall economy, we would still expect 2017 to be a slower year on the Commercial Property front than 2016.

 Retail Property expected to again be the “relative outperformer” in a weaker property period, while Office and Industrial could see some capital depreciation (net of capital expenditure)

Our econometric model-driven forecasts are for Retail Property Capital Growth to slow to 3.9% in 2017, which is low but positive. However, as was typical in the last 2 periods of market weakness, we project some capital depreciation (remembering that this data is net of capital expenditure) for both the Industrial and Office Property Sectors. These 2 sectors already showed significantly weaker capital growth than the Retail Property Sector in the 1st half of 2016, according to IPD bi-annual stats, and have typically performed weaker than Retail Property in the past 2 periods of market weakness.

Last modified on Tuesday, 15 November 2016 10:18

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