24 Jun 2004 :

The buoyancy in the directly-held non-residential property sector continued in the first quarter of 2004, with capitalization rates maintaining their declining (strengthening) trend of the last few quarters.

This means that directly-held property is being rerated in a big way, say property economists Rode & Associates in the latest Rode's Report.

Capitalization rates decline when market values improve.
Even the capitalization rates for CBD offices have been coming down sharply, implying that investors' general sentiment towards offices in the city centres is improving, says Rode CEO Erwin Rode.

The improvement in capitalization rates can be attributed to a combination of reasons. "For one, capitalization rates seem to dive in the wake of the insatiable demand for directly-held non-residential property from listed funds and syndicators. Competing asset classes also seem to be fully priced, and capitalization rates are benefiting from investors' realization that inflation will most probably settle at a lower rate of 5%-6%. Lastly, capitalization rates may also be profiting from the promising growth in the demand for non-residential space," Rode says.

Not only declining capitalization rates point to improving conditions in the non-residential property market. The majority of property indicators show that an upswing in real rentals must be close.

On average, real decentralized office rentals were unchanged in the first quarter of 2004, after being in a downswing since early 2001 due to vacancy pressures. However, the sideways movement noticed in the quarter under review may be the first sign that relief is on its way. This follows on the robust office take-up (480.000m² in the past year), resulting in declining vacancies over the last few quarters.

As for the CBDs, national real office rentals continued to build on the increase noticed in the last quarter of 2004. The most encouraging improvement in real CBD office rentals was noticed in the Johannesburg CBD, albeit off a low base. Upticks were also recorded in the Pretoria and Durban CBDs, whilst real rentals in the Cape Town CBD moved sideways. But this recovery in rentals should not come as a big surprise, as office take-up has been healthy over the last year.

Real industrial rentals in Gauteng province were still caught in their long-lasting slump, although initial signs of a recovery were noticed. This is further evidenced by the BER's survey of manufacturing business-confidence and Investec's Purchasing Managers' Index, which both show that conditions for manufacturing are improving considerably.

This is an important development because the demand for locally manufactured goods is an important proxy for the demand for industrial space, which, in turn, should be positive for an upswing in real rentals.

Turning to the residential market, where house prices were still racing ahead, the Report sounds the alarm for upper-priced suburbs. "House prices of upper-priced suburbs in all the major cities are above replacement costs, which means that it is relatively more expensive to buy a newish existing house than to have one built - assuming that stand prices have been growing at the same rate as building costs. This is an indication that houses in the upper-priced bracket are in a bubble," according to Rode.

As for the flat rental market, it seems that the oversupply of residential rental accommodation has left its mark on the Johannesburg and Pretoria flat markets, with average rentals, after adjusting for building-cost inflation, trending lower. However, in Durban and Cape Town, the overall trend in real flat rentals has been sideways.