/ 7 May 2010

Weathering the storm

Weathering The Storm

With the World Cup almost upon us, much of the flurry of infrastructure development that has preceded the football showcase has now subsided.

The focus of the construction industry is likely to shift back towards the more everyday business of building that delivers value to the economy in the form of industrial, commercial and retail properties.

The commercial, industrial and retail market is a strong indicator for the rest of the South African economy because it shows not only the relative strength of consumers to buy products, but also the growth in employment.

With the global economy starting to recover from the recession and the South African economy with it, there is hope that the industrial and commercial property sector will see the benefits of the recovery.

Frank Berkely, managing executive of Nedbank Corporate Property Finance, says that although the market is in a better position than it was two years ago, it is still relatively flat compared with the growth eight months ago.

Steve Rennie, managing director of Rennie Property, says that the retail sector has borne the brunt of the pain from the recession. ‘If you own a shopping centre then your tenants pay either a fixed monthly rent or a percentage of turnover, whichever is higher. Shopping centres depend on that percentage to deliver their profits and as consumer spending has slipped the amount of retailers paying only the lower fixed rent has increased, placing pressure on the centre owners.”

Many companies have been living off their cash reserves for the past year and when these run out the effect of the recession on this sector may become more apparent, he says.

‘In the retail sector the big regional shopping centres have weathered the recession the best, with the smaller local centres and niche centres feeling the brunt of the recession, and this is still the case,” says Berkely.

Although the recession is technically over, Berkely does not expect the market to pick up in the next 12 months. He says that the recovery in the sector is largely dependent on other sectors of the economy enjoying greater success.

With greater employment in the market, retail sales should increase and this will have a corresponding effect on industrial production and consequently on the commercial sector.

‘It isn’t possible to pick out one area that will recover faster than the others as they are all intrinsically interlinked. ‘It may happen that one of the three areas sees a recovery a few months before the others, but in a market where new developments have an 18- to 24-month lead time this is largely insignificant,” he says.

‘We need to take into account that unemployment in South Africa is still on the increase and the global economy has still not recovered from the recession and the uncertainty around what the fallout will be from Greece and some other European economies.

‘These can all have an impact on the South African economy, but it is almost impossible to determine what this impact is likely to be,” Berkely says.

The industrial, retail and commercial property sector is, like many other parts of the economy, governed by a cycle. This seven-year cycle covers the increase in demand driven by a growing economy and the reaction of the property developers covers the increased demand.

New developments typically satisfy the demand, which pushes down property prices. The market enters a period in which supply exceeds demand until growth in the economy once more drives new developments.

Rennie says that at present the market has not moved from a position of oversupply to one of overdemand. Even once it does reverse, it could still be three years before the developers can bring new projects to the market.

‘There was a lot of investment but the prices for property were higher than ever before, but when the recession hit this saw rental prices easing off,” he says. ‘Right now we have seen the vacancy rate dropping off from its recent highs of 12% to 13% to a more respectable 8% to 9%.”

Developers are always looking to create new opportunities and there are always buyers and sellers in the market, but the banks effectively act as a handbrake on new developments, he says.

‘Developers will always struggle to get financing in a weak market or the banks will simply come on board with a smaller percentage of the required finance, making it necessary to find their funding elsewhere.”

Berkely says that although there was a liquidity crunch internationally about 18 months ago, this has largely eased and the banks have returned to their normal policies of granting loans for developments.

‘These loans are typically concluded over a 10-year period and, as such, we expect to see cycles in the business environment. The fact
that very few developments in South Africa are built on a speculative basis (without tenants already lined up) the risk associated with developments is lower than might otherwise be the case,” he says.

One of the things that has shielded the South African market from the meltdowns that have been experienced internationally has been the size of the local economy, he says.

Because the South African economy is relatively small, the banks are much closer to the environment that they are investing in and that gives them a better perspective on what the market requires in terms of new developments.

Rennie points out that the key challenge for property investors remains the political stability of the country. ‘Institutional investors are typically working with sums greater than R100-million and for that they need to be assured of political stability in the country.

‘However, there are real benefits in the South African market in that lease agreements have an annual escalation clause built into them, something which is not typical in Europe. This allows investors to see a regular return on their investment, as well as ensuring that this return increases each year.”

It is this kind of market structure that has seen property outperform equities as an investment vehicle over the past three years. But the economic difficulties that many European countries are experiencing mean that property investors are looking for investment opportunities closer to home.

What remains to be seen is how the post-World Cup South African economy performs. There is the possibility that the end of the euphoria surrounding the event will result in the economy slipping back into recession or it may pick up on the back of tourism revenues from the tournament and the start of projects that have been held back to avoid clashing with the soccer.

For developers, the end of World Cup construction is likely to give them a stronger bargaining position with the construction companies and this may provide the impetus that the industrial, commercial and retail property sector needs.