Outside of business rescue, I love history. It was no surprise then that my family and I decided live in one of the oldest (and largest) suburbs in Johannesburg. Sandwiched between Jeppestown, Malvern and the East Rand, there is a fair bit of activity that carries on in the surrounding areas at night which tends to spill into our suburb.
This made it necessary for the residents in the suburb to form a community policing forum which patrols the immediate vicinity every night of the week. On a recent patrol, I noticed that no less than seven properties were on sale in a three-block vicinity of my home. South Africans are under significant financial pressure and the property market is not exactly booming at the moment.
Along with the tourism and travel industries, the property industry was severely impacted by the disruption associated with Covid-19. Deloitte recently released a report which discusses this in more detail.
Key insights
As expected from Deloitte, the report is very thorough and discussed a few significant issues.
Some of the key themes that emerged from the survey are:
• Liquidity pressures faced by tenants and devaluation of properties were the biggest impact on REIT portfolios;
• Offering rental relief was the most common action provided by landlords to support tenants during the first wave of the Covid-19;
• Prudent cashflow management was the most common action taken by landlords to manage their impact of Covid-19;
• Repositioning for recovery involves deepening relationships with tenants, strategy refinement, strengthening balance sheets and re-affirmation of commitment to green initiatives/ environmental social and governance (ESG);
• Tenants have emerged as some of the real winners of Covid-19 from the following perspective:
- The negotiating power is favour of tenants given the excess capacity in the market. There is no better time to negotiate favourable rental terms
- The need to improve customer experience and satisfaction: most of the respondents have cited their plans to improve tenants’ experience, increase engagement with tenants and understand tenants evolving business needs in order to offer the right solutions
- Smart real estate initiatives are expected to take centre stage in some of the REIT strategies, which will help tenants to cut costs as some of the data may be shared with them.
- Some of the respondents have highlighted the need for flexibility in structuring lease agreements with tenants
Deloitte also found that:
• The real estate sector is likely to remain depressed in the next two to three years due to the following:
- it was already in a cyclical down turn prior to Covid-19;
- it is a lagging sector and its performance largely tracks gross domestic product (GDP) performance;
- it is a bear market, there is excess supply in the market and not enough demand; and
- the recent riots which disrupted economic activity in some parts of Gauteng and KZN. However some of the respondents expect recovery in the next 12 months;
• There is a need to have a clear and defined digital transformation roadmap in place as most respondents indicated that digital transformation is important to their business strategy but they are not directly aware of whether their business has a roadmap in place.
Photo By: Canva
The listed property sector in South Africa has been impacted the most by Covid-19
The report pointed out that the SA Listed Property Index (SAPI) has been the worst performing sector on the Johannesburg Stock Exchange (JSE) in South Africa since December 2019.
During March 2020, where uncertainty in financial markets was at its highest, the SAPI was as much as 56% lower than the corresponding close on 31 December 2019. By comparison, the JSE All Share Index (ALSI) declined by as much as 34% compared to the December 2019 levels, demonstrating that, in general, listed equities have not been as severely impacted.
The report adds that the SAPI started to recover from November 2020, boosted by greater optimism regarding global economic growth following the expectations of the widespread use of vaccines against Covid-19. But, by 31 December 2021, the index was still 23% off the December 2019 level, which implies the recovery still has a long way to go. Comparatively, the ALSI closed around 29% higher than the December 2019 close.
Most REITs are trading below their net asset values (NAV) based on their respective market capitalisations at 31 December 2021. Based on our analysis at 31 December 2021, the mean and median observed discounts to NAV were calculated at 22% and 25% respectively.
The report points out that this is echoed in the Rode’s Report on the South African Property Market (Q3 2021) (Rode’s Report), where discounts to NAV of between 20% and 30% were reported. In contrast, Stor-Age Property REIT Limited (a highly specialised property fund focused on the self storage sector) and Equites Property Fund Limited (specialist logistics REIT ) are trading at premiums to their respective net asset values. Not all broader property sectors have been impacted in the same way by the COVID-19 outbreak, with the Stor-Age and Equities property portfolios proving to be resilient to the pandemic.
Winners and losers in South Africa’s broader property sector
The report points out that one of the big winners has been the residential property market, that saw sales surge due to record low interest rates. Nationally, nominal house prices increased by 3% year on year (YoY) in September 2021, slowing from the pandemic peak of 5.1% in April 2021, according to FNB data. There is a growing risk that the South African Reserve Bank (SARB) could continue with a gradual rise in the repurchase rate given its expected trajectory for headline inflation and upside risks. Although reported national flat vacancies are decreasing since their peak in Q4 2020 (13.1%), they are still well above pre-pandemic levels.
The report adds that industrial property has been the sector that has been proving resilient during the pandemic – it has seen rental growth of about 3% YoY and vacancies below 5%. The 2.6 points is considered ‘low’ on the Rode’s vacancy scale of 1-9, implying that less than 5% of industrial properties are vacant. Although the “hard” manufacturing sub-sector is under severe pressure, the logistics sub-sector is driving the industrial property market recovery. Rodes highlights that a positive for the industrial market is the ever-growing demand for new-generation warehouses with modern racking systems and distribution space for strongly growing online retail sales.
The office property oversupply is significant and vacancy rates nationally reached an all time high of 15.4% at the end of September 2021, according to SAPOA. Rode’s expects vacancy rates to deteriorate further to 20%, or even 25%, in the next year as leases expire and tenants procure less space. The requirement for office space in a post-pandemic world remains one of the key uncertainties facing the sector. Current expectations indicate that the need for office space for larger corporations will remain, although the days of 5-day working weeks are likely gone as flexible/hybrid working models gain momentum.
Photo By: Canva
Retail property, which was initially hard-hit by lockdowns, is seeing a recovery. While the retail sector has performed better in 2021, such an increase is expected given the lower base of 2020. Based on data obtained from Statistics SA, retail sales for the eleven months ending November 2021 were lower than the comparable period in 2019. The unrest in July 2021 has also impacted the recovery. The retail sector is expected to continue to recover over the short term due to better economic growth and low interest rates. Future Covid-19 mutations and waves of infection may further impact the sector’s recovery.
Opportunities and hidden gems
Common sense tells us that financially distressed clients need to focus on cash flow management and keep spending to a minimum for the immediate future.
However, a growing challenge that needs to be addressed is the future of work and the role that returning to the office plays in this. For companies who are looking to expand, the buyer’s market that we are currently experiencing means that tenants and future tenants will have a greater bargaining chip when it comes to negotiations. Companies may be able to take advantage of opportunities to unearth hidden gems where they can get more value for their capital when it comes to property rental. It may sound absurd, but the time to shop for your new office space/expanded office space is now.
The Mystery Practitioner is an industry commentator that focuses on the shifting dynamics and innovative thinking that BRPS and turnaround professionals will need to embrace in order to achieve success in their businesses.
