Commercial Property recovery?

State leasing contracts may give property investors a reliable cash flow, while sales of distressed commercial properties may mean that bargains can still be found.

The South African commercial property market is showing signs of recovery in the coming year with certain areas offering reasonable prospects for higher profits, claims Mergence Africa Property Fund.

“There is a cautiously positive outlook for investments in commercial property in South Africa with a number of bright spots around the country offering the potential for higher-than-average returns for investors,” claims Mergence’s Izak Petersen.

He says that property owners with the right black economic empower credentials will benefit from leases from government departments and state-owned enterprises. “These leases represent a low risk in the testing economic environment,” says Petersen.

He says that property investors need to have a mix of government and national corporate tenants in their portfolios as these contracts improve the cash flow reliability, which is essential for property investment.

“Government tenancies put investors in the beneficial position of being default-free,” he says.

Referring to the risk profile, Petersen points out that corporate downsizing and the growing number of liquidations have boosted the rental default levels and when this is combined with higher municipal and electricity charges it makes the commercial property market challenging.

“For those property funds looking to acquire new properties, the increase in distressed selling may mean that bargains are available and could lead to more quality stock coming into the market,” he says.

According to the latest SAPOA Office Vacancy Survey, prime office space in Johannesburg and Cape Townwas either fully let or had vacancy levels of less than one percent.

UK commercial property an investment for South Africans

The continued recovery of the UK commercial property market, coupled with the strengthening of the rand relative to pound sterling, has presented South African investors with a unique opportunity to invest in the UK while capitalising on the recovery cycle.

This is according to Eric Mounier, CEO of the Pam Golding Properties/Athanor International Property Investments joint venture which markets direct offshore commercial property investments.

"Since 2000, the joint venture has been involved in property asset transactions valued at over R5 billion and currently is involved in supporting over 40 active property investments,he said.

Despite commercial property values in the UK being devalued by over 40 percent following the global credit crisis, the asset management team has been successful in ensuring all properties under management remain operational and income producing, and favourably positioned to take advantage of the expected recovery cycle.

Illustrating the UK commercial property market's recovery is the Investment Property Databank (IPD) UK monthly index, which indicated a 0.1% growth in un-geared commercial property values for the month of October 2010.

This growth concluded the 15th consecutive month of capital appreciation, bringing the compounded upturn in values since the recovery to 15.9%, according to the IPD.
While there had been significant growth during this period there was still a long way to go to get back to the values prior to the global credit crisis.

"This trend is supportive of the market commentary which indicates that investors are starting to re-enter the market, with the UK providing a popular investment destination.

During the period of downturn following the global credit crunch, the UK experienced a significant re-pricing of commercial property values, and as a result investors were taking advantage of the favourable prices which were now possible.

In addition, during the past year we have seen a significant strengthening of the rand against the pound with a slight reversal of this trend more recently, Mounier said.

For those taking the view that the pound was likely to remain strong against the rand and the euro, the timing seemed opportune to invest in a solid pound-related asset class, he added.

The aim of the Athanor/PGP JV is to facilitate property investments which derive the vast majority of their returns from the large net yields currently available as a result of the positive gap between the rental income and the cost of finance. "

Consequently, less dependence was placed on capital growth to achieve the expected return which reduced the risk associated with these investments.

As an example of such an investment, a recently launched property in Parkhouse West Industrial Estate in Newcastle-under-Lyme in Staffordshire, England, is expected to produce cash flow of around 11 percent per annum, from which a portion will be used to pay down the bank loan and the remainder available to return to investors.

The majority of the projected return will come from the annual cash flow," he said.

Property Predictions for 2011 - South Africa

In 2011 the greatest challenge for the auction industry will be to refocus on a buyer's market still constrained with a shortage of demand and an over supply of non-income producing properties.

As the country gets used to a long, hard and bumpy recovery, the economic headwinds will still be strong and unemployment rates alarmingly high.

While the lowest interest rates in 30 years will boost sentiment and cause a bounce in properties with reliable cash flow, the favourable interest rate environment won't be a magic pill which quickly relieves the downturn.

Finding the right buyers at auctions and getting funding will remain challenging.

Business confidence will be dependent on a host of local and international issues; including fears of a potential sovereign debt crisis in Europe.

While distress at retail level may slow with lower interest rates, and banks now well geared up to assist defaulting clients, corporate distress will grow with larger liquidations bringing higher value assets to the auction floor.

High value bankruptcies will increase throughout the year, presenting opportunistic purchasing like never before seen in South Africa.

As liquidators and banks get more desperate to offload bad debts and an oversupply of development land, a sweet spot will emerge for investors with access to financing as they pick up these assets at bargain prices.

The residential property market will remain flat for most of the year with a stronger recovery at entry level. Investors will snap up properties below R1 million, which for the first time in many years will provide stronger returns than cash in the bank.

The middle market will remain flat for some time as it deals with oversupply in newer residential areas.

The luxury residential market across the country will remain weak all year, with little help from interest rates, and a strong Rand constraining international demand.

Leisure residential properties at the coast, on golf courses and in other non-urban areas will also remain flat with many properties being sold at auction below replacement value.

Next year two pieces of legislation may have a major impact on the auction sector. The Consumer Protection Act will change a wide range of issues regarding the auction process, mandates and sales processes; these are all designed to look after the consumer's interests.

The new Companies Act will also have a material effect with the introduction of Business Recovery.

This may cause an initial slowdown in liquidations as companies go through the business recovery process.

It is possible that liquidations may increase later in the year as banks rush to secure their positions on property exposures. Either way, it will have a material impact on the auction sector.

The commercial property market will become two-tiered; good properties with strong covenants and reliable cash flow will experience a surge in demand as investors look to place their cash in areas that achieve greater returns than bank deposits.

Blocks of flats, retail property and key industrial sites will form the strongest part of the market.

The office market will remain mild but A-Grade properties in prime locations will attract strong demand on the auction floor.

An area of concern will be hotels, guest houses and leisure resorts which will battle in 2011 and may hit the auction floor with little demand.

Foreign investors eye South African real estate

South Africa is seen as one of the growth nodes and the gateway to the continent.

At a recent commercial property conference held in central London, a strong focus was taken on distressed property markets, whereby it was confirmed that advanced countries would still see pain in their property markets for some time but developing economies would strongly outperform sluggish northern hemisphere nations.

According to Auction Alliance, CEO, Rael Levitt, who attended the conference at the invitation of the Royal Institute of Chartered Surveyors, many speakers, economists and analysts felt that China, India, South America and Africa were the regions where property markets would recover quickest and provide the strongest returns as the global economy returns to health over the next five years.

South Africa was mentioned as one of the growth nodes where the country was not only accommodating an influx of foreign labour from other African countries but was rapidly becoming the gateway to the continent.

According to Levitt, several delegates believed that when international behemoths such as Walmart, NTT and Zara invested in Africa, they would use South Africa as their regional head office for a pan African roll out strategy. "This creates demand for local, commercial real estate," says Levitt who followed the conference with a four day tour of the UK's largest auction houses, including Allsop, Cushman and Wakefield, Barnard Marcus and others. ‘'This is an annual trip I take to see whether our auction business is lined up with the world's most established and reputable auction companies."According to Levitt, this was the first time that he felt that South African property was way ahead of European markets, which are in great distress at the moment. "They see South Africa as an exciting emerging economy and, despite the global downturn, a strong investment destination, which would still grow sharply."

A strong Rand, first world infrastructure and renewed foreign investment will make South Africa a popular choice for global property investors, explained Levitt. One must remember that on the commercial property side, besides the investment in Cape Town's V&A Waterfront, there hasn't been enormous foreign investment in local real estate. With the strength of our emerging economy, now palatable to offshore investors, we may finally see foreign investors chasing South African industrial, office and retail property.

Unlike the UK and the USA, credit growth in South Africa was pushed up mainly by demand from the household sector, and this sector is likely to remain the main driver of credit growth during the second half of the year, following the interest rate cuts, income growth and some improvement in employment prospects.

Although many analysts believe that interest rates are likely to remain unchanged at the next meeting of the Reserve Bank's Monetary Policy Committee, given the uncertain nature of the recovery, a favourable inflation outlook and a strong rand, a further rate cut remains a possibility. "We have already found that the last rate cut gave impetus to the market and increased buyer demand.

Another rate cut will lower yields and boost the market," said Levitt. This is a positive for foreign investment and we see interest growing in both the physical and listed real estate sectors.

Unlike many banks globally, the five major South African banks are extending credit, albeit cautiously. Growth in mortgages was firm in August, rising by 1.1% m-o-m and 4.8% y-o-y. Despite the fact that the overall trend remains weak, consumer confidence is likely to remain firm during the remainder of the year as worries about job losses abate with better general economic conditions compared to last year.

Foreign investors take comfort in the strength of South African banks and, despite HSBC not pursuing the acquisition of Nedbank, South African banks are held in high regard for the way they are weathering the global downturn. Another positive factor for foreign investors is the fact that household balance sheets should improve following high wage settlements reached during the negotiation season. This, together with lower interest rates and inflation, should keep household spending positive and stimulate demand for credit.

However, part of the benefit could be offset by tight credit standards and high debt levels, which will prompt some consumers to use the favourable interest rate environment to settle their debt rather than applying for more credit.

Whilst corporate demand for credit is likely to remain weak as the private sector remains wary of accelerating capital expenditure in the face of ample spare capacity and the fragile economic recovery, foreign investment in retail, services and mining may boost business confidence in the medium term. T

hese are all optimistic signs for the commercial property market and the reasons why South Africa is being viewed as an attractive investment destination.

Commercial property under pressure

The outlook for the commercial property market is bleak with developers and bankers taking a far more cautious view of this sector says property economist Francois Viruly of the University of the Witwatersrand’s School of Construction Economics and Management.

He warns that there has been a dramatic drop in the number of developments underway and even existing projects are being reassessed to avoid adding to the widespread over-supply of office accommodation.

“Office vacancy rates have increased since last year and this picture is unlikely to change before 2011 or perhaps 2012,” he warns. “Increased spending in the retail sector might have an impact on reducing vacancy rates in retail shopping centres in the short term,” he claims.

Hyprop Investment’s Mike Rodel says that the time is ripe to get particularly good rental deals from agents or developers who are keen to boost occupancy levels. Rodel says that Hyprop is expecting national retail sales growth of between 7% and 10% over the next two years with regional centres growing by up to 12%.

Rodel says that the margin of operating costs to gross rentals has continued to rise and increased from 30% two years ago to 40% now and high vacancy rates have made it difficult for owners to pass the rising costs on to the tenants.

Viruly warns that the biggest difficulty facing developers is to keep the operating costs in retail centres under control as the operating margins are too high at the moment and need to be brought back under control.

“There are likely to be some retail opportunities that do arise in the short term – such as for retail space on Gautrain stations – but the retail property market will remain under pressure until at least the second half of next year,” says Viruly.

Broll says that while there has been pressure on the retail and office market, there are still some impressive deals being done. The company recently sold two investment properties in Cape Town.

The first, 43 Bloulelie Crescent in Plattekloof sold for R13,5-million and 5 Ravenscraig Road in Woodstock sold for R33,75-million.

The Bloulelie Crescent property is let out to medical professionals while the Ravenscraig Road building is home to a large printing firm in a traditional industrial area.

According to Sean Berowsky, national property investment specialist at Broll, the interest levels from investment buyers has remained high, particularly for prime commercial and industrial properties.

He concedes that transactions have been restricted by the limited negotiability of sellers because of prevailing low interest rates and the limited stock that’s available.

“The difficult funding environment facing buyers means that there must be a substantial injection of equity,” he says. “Well-tenanted properties with good income streams are still easy to sell whereas buildings with high vacancy rates are not attracting much interest at all,” he adds.