Commercial Property Market Review by JHI

"In an economically unstable environment the South African commercial property market in general has been performing well, with IPD figures reflecting that the industrial sector has for the third time in a row outperformed other commercial sectors." According to Marna van der Walt - CEO for independent property services company JHI.

"However," added van der Walt, "the good performance of the overall property market is not expected to continue. This due to the economic slowdown, increased interest rates and its effect on property and prices, the general economic outlook and declining business confidence, escalating construction costs and the impact of power cuts."

In her review of the industry and the company's extensive 31 billion assets under management portfolio, Van der Walt highlighted that in terms of the:

1) The Industrial Sector

The good performance of the industrial sector over the last few years can be attributed to by improved economic conditions, low interest rates and the growth in manufacturing production. However, the revised projection of GDP growth (from 5% to around 3%), rising interest rates as well as a slowdown in manufacturing production dims the outlook for mines and factories, thereby impacting on the industrial sector as a whole.

The current manufacturing environment is severely impacted by a weaker demand for locally produced interest rate sensitive goods, continuous power cuts and a general weakness in global economies.

But, it is not all gloom and doom. In realizing the importance of the industrial sector, the government has implemented the Industrial Policy Action Plan (IPAP) and pledged R2.3 billion over the next three years for the strengthening and diversification of the industrial sector.

In general, industrial vacancies have been on the decline and rentals for new space are well above R40/m2 gross for prime industrial space. Existing tenants have little choice in the availability of spaces and face the situation where, due to continued rental growth and high building costs, they have to make provision for 30% to 50% rentals increases.

2) The Retail Sector

Due to the changing local economic environment, retailers were more cautious this year because of the weaker retail environment. Over the last few years there has been an explosion in the amount of retail space coming on-stream. This has largely been driven by retailer demand, which is now, however, expected to drop off due to decreased consumer spending.

The current economic environment is putting pressure on the retail industry. Retailers that are largely driven by credit are starting to be negatively affected by the interest rate environment. The effect of spending less on credit is affect clothing and furniture retailers more than food retailers as consumers avoid credit retailers and start spending at cash retailers.

Also, decreased consumer spending is putting pressure on retail tenants as some are battling to meet contractual rental payments. In order to avoid high vacancies, landlord should look at some form or rental reduction in order to assist battling tenants that have a long-term future in a centre. Retail tenants that are affected the most are niche shops that are selling non-essential items.

Furthermore, interest rate increases as well as higher fuel prices and food cost have resulted in changing shopping destination. Consumers who recently were able to shop in higher-income outlets are moving back to middle-income outlets and from middle-income outlets to lower-income outlets. Another sign that consumers are under pressure, is personal insolvency figures which is on the rise.

3) The Office Sector

Notwithstanding the overall performance of the office sector, office nodes in all the major cities are starting to run out of available office space. The demand for space has led to good rental growth, which is expected to continue over the next twelve months.

In general, tenants are battling to find good quality available space in prime areas for under R100/m2. Just recently, top-end rentals in prime areas, such as Sandton and the V&A Waterfront were around the R90/m2 mark.

Currently, new space in Sandton is on the market for around R150/m2 to R180m2, with asking rentals in Melrose Arch surpassing the Sandton Business District at around R200/m2. Rentals achieved for new developments in the northern Johannesburg decentralized nodes are at around R120/m2 to R180/m2.

Furthermore, with vacancies at a record low, the demand for new space is increasing with major users of office space reverting to the construction of new buildings. The market is responding to this demand, with a number of new developments currently under construction or in the pipeline.

However, the rising cost of construction is exerting downward pressure on profit margins, which will cause further increases in rental rates. In addition, the shortage of building material, caused by large project such as the Gautrain and projects for the 2010 World Cup, is further driving up construction prices, which puts further upward pressure on rental rates.

Demand for space and the availability of zoned, vacant land are pushing up land prices, which will further contribute, to increased rentals in order to make new developments financially viable.

4) Land

The demand for commercial space over the last year or so, has placed pressure on the availability and pricing of vacant, zoned land. Current owners are holding out for higher prices, which are creating a further shortage of land suitable for commercial developments, directly affecting rental growth with much higher asking rentals for new and existing developments.

Furthermore, rising building costs and the availability of building material, has also placed upwards pressure on asking rentals. The increasing growth in building costs could dampen development opportunities as rentals will need to rise considerably before financial feasibilities become viable.

However, the positive aspect is that high building costs will limit the risk of oversupplying the market.

5) Operating Costs

Investors should keep an eye on operating costs which may spiral out of control due to rising inflation, interest rate hikes and other general increases. Property operating costs largely reflect service items such as municipal charges, repair and maintenance expenses and security charges. Typical increases that have affected operating cost over the last few months include :

Real wage increases which make up a high percentage of input costs;

Increased municipal valuations. The new rating system has seen assessment rates levied against the total value of the property compared to land only in the past;

Rise in the petrol price which serves to increase contractor prices.

Imported cost inputs for items such as lifts, escalators and air-conditioning which are affected by currency fluctuation; and

Building insurance cost which has risen significantly over the last few years.

One of the biggest factors in increased operating expenses is assessment rates which, in the current property market are exclude from gross rental, owing to the unpredictability that its inclusion can create. Furthermore, the rising cost of other municipal charges such as water, electricity and refuse removal are also contributing to rising operating costs.

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