Comment - Impact of electricity by Estienne de Klerk

If you own undeveloped land and are awaiting rezoning and other approvals including electricity supply, with interest rates heading north, you should be worried.

Developers will struggle to get development plans to the point where construction can begin.

In general, the high interest rate environment which is compounded by the construction inflation, planning approval delays and the utility supply situation looks set to result in a marked reduction in new construction of commercial property over the next year.

This electricity crisis has certainly added a level of management complexity to commercial property investment and many property companies have elected to employ energy consultants on a permanent basis to assist in dealing with these technical issues.

In several cases developments for which the requisite approvals have not been obtained have been postponed, a move, which could jeopardise the projects’ feasibility with the impact of construction inflation and a high interest rate environment. In certain cases all approvals have been obtained, but to ensure that Eskom or the relevant municipality actually connect the development to the network, developers and property companies have delayed construction to obtain the requisite certainty of supply.

Real estate companies have been pressured by Eskom and DTI to commit to savings in electricity consumption of up to 15%. This creates a complex situation as in most cases the clients in the buildings are actually the major electricity users who are responsible to realise the savings. There is thus a “disconnect” between the capital investment required for energy efficient technologies by the property owner and the savings benefits to be derived by the property occupant.

For the property owner to deliver on the electricity- saving requirements, a savings programme would have to be coordinated with the clients by demonstrating the benefits of cost-savings from the energy saving devices installed in the building to clients’ electricity account, to enable the recovery of the capital cost.

Throughout 2007 Growthpoint proactively assessed the electricity supply requirements at several of its buildings with the view to providing an uninterrupted supply of power. In areas like Midrand and Sandton it has properties to which we have provided full backup-power to our clients which require an uninterrupted supply.

The inability of City Power to provide additional electricity supply to Growthpoint Business Park in Midrand resulted in a delay to a number of demand driven developments, where the approved bulk is in hand, until the required increases in the existing supply could be guaranteed. This increase in supply does not appear to be imminent. The problem is also not specific to Growthpoint Properties. For example, several developers in Bryanston have also been stranded without electricity.

Providing uninterrupted supply to multi-tenanted buildings comes with additional risk and increased cost of insurance, with flammable fuel stored at buildings. It is not always possible to obtain a return on the additional capital cost committed to provide the uninterrupted power, as not all the existing tenants in the building may require full backup and thus are not prepared to pay for it. Where new tenants are attracted to the building it is easier to make the recovery of this capital expenditure as part of the offer of lease.

Assisting clients to facilitate an uninterrupted supply of electricity has become essential to ensure their continuity of business. Occupant businesses, which suffer due to the electricity supply problems will ultimately impact on the property owner’s bottom line.

The electricity shortage “threat” does however offer real estate investors a few opportunities. The resultant increase in demand for space, due to the reduction in new developments, could lead to increased rentals. This makes the refurbishment of existing buildings a viable opportunity. Existing buildings usually have the requisite utility services in place and are appropriately zoned. This trend will see the older portion of property portfolios being upgraded, protecting the property owner against increased competition from new developments.

Real estate investors are also assessing previously “nice-to-have” energy efficient technologies, now that these technologies are required to obtain the necessary approvals for the supply of electricity. The cost of the technology does translate into a higher cost of development and will force market rentals to move up in order for investors to achieve the required returns. This pressure will certainly have a positive impact on rentals in addition to construction inflation, which has already driven rentals north on new lettings and renewals.

Demonstrating this, rentals currently in force in the Growthpoint portfolio are approximately 50% of the rentals required for new developments to achieve a market return on investment. This should translate into solid growth for the future assuming demand for retail, office and industrial space remains firm.

Estienne de Klerk - fund executive, Growthpoint Properties Limited
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