SOUTH AFRICAN by gyvwpsjkko


									                                                               SOUTH AFRICAN
                                                               PROPERTY MARKET
                                                               T R E N DS R E P O R T
                                                               MAY 2010

    THE VOICE OF COMMERCIAL PROPERTY                                                                   By Jess Cleland and Marc Schneider

South African property returns have declined for                       African returns read well in a global context. Once again South
                                                                       Africa has produced the highest nominal returns of all countries
the second consecutive year, although they still
                                                                       measured by IPD (at the time of writing 11 countries’ results had
managed to produce a marginally positive capital                       been published).
growth in a market with weakened fundamentals.
                                                                       Fig 2: Global property total returns, % pa
With the beginnings of a turnaround in economic
conditions and business confidence, however, it
appears that the South African property market may
emerge from the global downturn slightly battered
but relatively unscathed compared to other
Resilience in the global storm
South African property returns have weathered the global
downturn remarkably well. Despite the second consecutive year
of declines in returns, property performance remains strongly in the
black with a nominal 8.7% total return for the year to December

While not immune to the forces applied from global financial
markets and recession – indeed, yields softened over the year,
albeit by only 25 basis points – this negative effect on capital
growth was offset by continuing income growth. The net result
was a marginally positive 0.3% capital growth, underpinned by a
steady, strong income return of 8.4%.

Fig 1: SA property returns, % pa                                                                        Source: IPD Multinational Index 2009

                                                                       One of only a handful of countries to produce a positive total
                                                                       return, South Africa is also the only country to date where capital
                                                                       growth did not decline at an all property level. This relative strength
                                                                       can be ascribed to less severe financial disruption than in other
                                                                       markets and minimal speculative development. As a result South
                                                                       African property has not been re-priced to the extent that it has in
                                                                       other mature markets.

                                                                       Even considering the unique positive capital growth in 2009, it is the
                                                                       income return of the South African property market that is once
                                                                       again the differentiator between it and other markets, with an
                                                                       average spread of almost 200 basis points to most other countries.

                                                                       The spread in returns between the retail, office and industrial
                                                                       sectors is very tight – in fact it is the smallest inter-sector spread in
                             Source: IPD South African Digest 2009     the history of the index – however there are different conditions
                                                                       in the underlying fundamentals driving these returns. Total return
Supported by relatively strong fundamentals and propped up             ranged from 8.0% for offices, to 8.7% for industrials and 8.8% for
by inflation higher than most IPD measured countries, the South         retails.

Fig 3: SA property returns by sector, % pa                                 experienced in the late 1990s for each respective sector, with
                                                                           the retail sector displaying lower volatility and a more gradual
                                                                           upswing. Vacancies now stand at 4.8% for retail, 10.6% for office
                                                                           and 6.7% for industrial.

                                                                           Economic Overview: Gaining
                                                                           As a country that has qualities of both a relatively mature
                                                                           developed economy in an African context, on the one hand, as
                                                                           well as that of an emerging market in the global context, on the
                                                                           other, it is fairly evident that that South Africa was to be impacted
                                                                           by the financial and economic crisis/recession on a lagged and
                                                                           somewhat buffered basis.

                                                                           In simple terms, the quantum and degree of the financial credit
                                                                           crunch was relatively limited, however the reality of growing global
                                                                           economic linkages implied that its economy was to endure a
                                                                           significant recession. The recessionary impact was to take place
                                                                           behind the curve of the major developed economies with which
                                                                           it has strong trading ties. The extent of diminishing trade through
                                                                           2009 is reflected in the below graph whereby both import and
                                                                           export activity was severely curtailed.

                                                                           Fig 4: SA Global trade growth, % y/y

                                   Source: IPD South African Digest 2009

Net income growth remains strong and above inflation across
all sectors, however sectors are reflecting different points in the
market cycle. Retail income growth peaked in 2007, and has
declined to 8.0% at the end of 2009. Both offices and industrials
have recovered from negative income growth in 2002, and while
offices have continued to improve to 14.6% for 2009, industrials are
below their 2007 peak with 12.0% for 2009

As a result of contracted rental increases, this continuous strong
income growth has helped support capital values to date.
Downward pressure on capital growth, on the other hand, is
coming from softening yields across the board.

In regards to yields, the industrial sector appears to be lagging
slightly but catching up fast. After four consecutive years of
significant yield compression, 2008 saw the first upward movement
in yields in the retail and office sectors, by 40 basis points and
15 basis points respectively. Again the relative positioning on                              Source: International Monetary Fund via Ecowin
the property cycle becomes apparent, with retail yields moving
out more mildly in 2009 by only 13 basis points, yet office yields          So just how bad was this recession?
accelerated with a 47 basis point movement in 2009.
                                                                           From a macro economic perspective, GDP growth turned
The industrial sector, by comparison, continued to experience              south in 2008 and in fact South Africa experienced a recession
firming yields into 2008, but in 2009 saw the largest yield movement        commencing with the fourth quarter 2008. The manufacturing and
of the three sectors with a 91 basis point softening. This change          mining sectors were the most severely impacted being resource/
re-establishes the positive spread of industrial yields over office         commodity based and hence influenced by global demand. This
yields, a position which was briefly – and arguably unsustainably           heralded the first recession in 17 years.
– reversed in 2008.
                                                                           Although the 2.8% peak-to-trough decline in GDP can be
Vacancy levels have risen significantly on the previous year’s level        considered modest as compared with experiences globally,
for all sectors. Indeed, the rates of increase are similar to those        nearly one million jobs were lost, representing about 7% of total
                                                                                  SOUTH AFRICAN
                                                                                  PROPERTY MARKET
                                                                                  T R EN D S R EPO RT
employment. By the third quarter of 2009, however, the economy         Fig 6 Consumer price inflation, % y/y
exited the recession and created some jobs in the last quarter
of 2009, albeit mainly in the informal sector, thereby reducing
the official jobless rate by 0.2% to 24.3%. Over the course of the
recession, the unemployment rate worsened from 21.9% in the
fourth quarter of 2008 and although employment is expected to
rise as the state of the economy improves, the pace of increase is
unlikely to match the drop in employment brought about by the

Fig 5: GDP growth vs property total return, % y/y

                                                                                                Source: Statistics South Africa via Ecowin

                                                                       Although domestic inflation eased during 2009, nominal returns
                                                                       were nevertheless substantially eroded to a real return of 2.3%.
                                                                       Real capital growth has in fact been negative for the past two
                                                                       years, which is more consistent with international results. Indeed,
              Source: IPD, International Monetary Fund via Ecowin      over the fifteen year history of the index, net capital growth has
                                                                       lagged inflation by 0.5% per annum. In other words, the real value
Perhaps the biggest impact for the performance of investment           of South African real estate has decreased over time, leaving
property has been the fragile recovery of household-driven sectors     income to deliver real returns.
such as the trade and finance which together account for ap-
proximately 35% of South Africa’s economic output. The benefit          Fig 7: Total return deflated by CPI, % pa
of diminishing demand became evident in the level of producer
price inflation which has in turn permitted the inflation target level
on the consumer front to be achieved by early 2010. Import pricing
was further bolstered by the relative strength of the local currency
in tandem with positive sentiment towards emerging markets in
general and commodity-based economies in particular.

The outlook on inflation is perhaps a little murkier than some
anticipate and more particularly given the significant impact that
the new energy pricing regime heralds for South Africa; in addition
the risk to currency weakening in concert with escalating fuel
prices cannot be discounted. Also to be factored in the mix is the
anticipation for business margin building following more than a
year of profitability squeezing.

                                                                                  Source: IPD Research, Statistics South Africa via Ecowin

The retail sector: Fragile but turning                                          The key test for retailers is the increasingly challenging operating
                                                                                cost environment, in particular the impact of electricity tariff hikes.
the corner                                                                      The burden of these rising costs will most likely be shared in some
There are some fairly significant structural challenges befalling the            proportion between landlords, tenants and consumers. Rising
sector, including rising unemployment, a debt hangover, negative                operating costs are a common issue facing all sectors, however
net wealth effects and a limited savings buffer. In a nutshell the              the retail sector has felt the pressure more intensely to date with a
economic health of consumers remains largely ‘critical but stable’.             27.6% increase in operating costs per square metre compared to
Furthermore the risks of an unbalanced and untimely unwinding                   the same time last year. At an average of R49.3 per square metre
in global government and policy stimuli over the next year or two               per month, operating costs now account for over 40% of the gross
could impact on the medium-term horizon. This notwithstand-                     rental received, the highest percentage in the history of the index
ing, improving growth prospects have begun to restore financial                  for retail.
markets and emerging markets have seen a significant influx of
                                                                                The traditional economic hubs of the country in 2009 produced
capital inflows into their economies.
                                                                                the lowest retail returns, whereas the smaller provincial markets
Historically the most stable of the three property sectors, retail was          were in fact the best performing, as shown in Figure 9. This could
the first sector to enter the downturn having reached its cyclical               in part be due to a slight lagging of the smaller regional markets
peak in 2005. In 2009 the sector experienced the gentlest deterio-              to the overall national economy, indeed Free State, Northwest
ration in returns of the three major market sectors, with annual total          and Limpopo provinces were the only retail markets to record an
return falling from 11.1% in 2008 to 8.8% in 2009.                              improvement in returns for 2009.

Indeed, retail was the only sector to avoid a negative capital                  Fig 9: Retail returns by province, % pa
growth in 2009, rather seeing a 0.9% positive capital return over
the 12 months. Considering that the capital growth for the
first six months of the year was only 0.1% according to the IPD
Biannual Indicator, the second half of the year showed a marked
improvement within the context of marginal returns. Income return
for the full year was 7.9%.

While retail sales have been falling over the past two years, there
are signs that the rate of decline is now slowing, and by end 2009 it
was apparent that the sector was turning the corner as evidenced
by the sales growth approaching zero as reflected in the below

After personal real income growth contracted in 2009, it is expected
to pick up to around 3% in 2010. This augurs well for retailers, as real
disposable income growth is the single best predictor of consumer

Fig 8: Retail sales, % y/y

                                                                                                              Source: IPD South African Digest 2009

                                                                                Offices: the supply and demand
                                                                                balancing act
                                                                                The broader finance sector was dealt a harsh blow in 2009, not
                                                                                only on account of the credit crisis generally, but also on account
                                                                                of eroding business conditions. Nevertheless by end 2009 the
                                                                                revival of the sector appeared to have emerged, this coming
                                                                                a little sooner than expected. Given the sector’s large impact
                                                                                on the economy standing at around 21.1% of GDP, as well as
                                                                                its employment impact accounting for about 22% of the total
                                   Source: Statistics South Africa via Ecowin   formal non-agricultural workforce, a turnaround bodes well for
                                                                                      SOUTH AFRICAN
                                                                                      PROPERTY MARKET
                                                                                      T R EN D S R EPO RT
commercial property generally. The concept of ‘jobless recovery’          June and December. This came as business confidence started to
is however of some concern.                                               turn upwards from its trough in March 2009, although by the end of
                                                                          2009 it had still only reached a neutral position.
The total financial turnover of all industries for the fourth quarter of
2009 increased by 5.5% compared with the revised third quarter            Even with a lower sensitivity to electricity price shocks than the
of 2009, with turnover increasing in five of the eight industries          other two main sectors, offices experienced an above inflation
covered in the survey. Between the fourth quarters of 2008 and            increase in operating costs per square metre with a 13.0% increase
2009 the increase in turnover was 5.3%. The third largest decrease        to R31.5 per square metre per month. Notwithstanding very strong
after mining and quarrying, was experienced by real estate and            income growth in the office sector over recent years, operating
other business services (excluding financial intermediation and            costs have been rising faster than incomes, and as such operating
insurance), and hints at the challenges that are still evident in the     costs now represent 36.7% of gross rent received. Although a
tertiary sector generally. This has a direct impact on the property       relative increase year on year, this figure is still comparatively low in
office market which has experienced a relatively high growth in            an historical context.
vacancies generally.
                                                                          As would be expected, Prime Grade Offices have outper-
Fig 10: Office vacancy rates, %                                            formed Secondary Grade Offices over the long term (15 years),
                                                                          also displaying lower volatility over the same period. Although
                                                                          producing a lower return in 2009, Prime Offices have had a strong
                                                                          average annualised nominal return of 12.7% over the past 15 years,
                                                                          compared to 11.9% for Secondary Offices. The main difference
                                                                          between the return characteristics of the two property types,
                                                                          however, is the volatility of returns. Prime Offices are historically
                                                                          more stable, with lower peaks and higher troughs. This translates
                                                                          into a return per unit of risk (using standard deviation as a proxy
                                                                          for risk) of 1.7% for Prime and 1.2% for Secondary Offices. Office
                                                                          Parks, however, have been the best performing office property
                                                                          type over the long term with a 16.5% average annual return over
                                                                          the past 15 years, at volatility similar to that of Prime Offices. This
                                                                          results in 2.2% return per unit of risk, substantially outperforming free
                                                                          standing offices.

                                                                          Fig 11: Office returns by property type, % pa

                              Source: IPD South African Digest 2009

Lasting equilibrium between supply and demand is rarely achieved
in the office sector. After years of oversupply during the late 1990s
– which resulted in vacancy rates skyrocketing to well over 20% –
a steep recovery was then achieved until the market peaked in
2007. The 2009 total return of 8.0% was comprised of a 9.3% income
return and -1.2% capital growth.

The 2007 peak in returns coincided with the turning point in the
vacancy cycle. In the four main office hubs of Johannesburg,
Cape Town, Durban and Pretoria, a net addition of space occurred
during 2009 yet the new supply was not met by net absorption.
While this suggests the beginning of a return to an oversupplied
market the imbalance is not as severe as in the late 1990s.

Net income growth in the office sector has been outstanding at
14.6% for 2009, in spite of the recent rises in vacancies. Regen-
eration efforts over the past decade focusing on the previously
decayed inner cities appear to be having a positive effect, with
inner city offices having the strongest income growth over the past
ten years.
                                                                                                         Source: IPD South African Digest 2009
As with the retail sector, offices experienced a slight improvement
over the second half of the year. The capital growth over the first six
months of 2009 was -2.7%, and yet only -1.2% for the full 12 months
of the year, implying a positive capital growth of 1.5% between

Manufacturing and industrial sectors:                                           Fig 13: Confidence Indicators (50 neutral)

A mixed bag
South Africa is increasingly reliant on global trade which was
severely impacted in 2008 through 2009. Some improvements to
manufacturing conditions are starting to emerge in the developed
economies in 2009. The positive impact of manufacturing on GDP
was fairly significant with 4th quarter-on- 3rd quarter growth of
10.1%. By year end manufacturing performance had increased to
3.2%. In support of the relatively stronger conditions, the Purchasing
Managers Index rallied to a level of 60.4 and 53.6 in early 2010,
thereby in theory taking the sector in back to pre-recession levels.

Fig 12: Industrial Production, % y/y

                                                                                                                 Source: SACB, FNB/BER via Ecowin

                                                                                The star property performer over the past decade, the industrial
                                                                                sector finally succumbed to economic forces and posted a
                                                                                negative capital growth of -0.6% for 2009. The first six months of the
                                                                                year produced a

                                                                                -0.4% capital growth, indicating that unlike retails and offices,
                                                                                industrial capital growth remained negative in the second half
                                                                                of the year. Overall total return was 8.7% for the sector, with the
                                                                                income return of 9.4% making up the difference.

                                   Source: Statistics South Africa via Ecowin   Strong historic fundamentals in the form of five consecutive years
                                                                                of sub four per cent vacancy levels, supply side constraints, a
Latest output in 2010 is however not as strong as expected and this             rebasing of rentals in the early 2000s and the emergence of the
once again points to the challenges of the economy as it moves                  hi tech segment as competition for office space came to an end
forward beyond the recession.                                                   in 2009. Industrial net income yields softened by 91 basis points in
                                                                                2009, more than the two years of softening combined in retail (53
The severity of decline in business conditions is reflected in the               basis points) and office (62 basis points). Vacancies concurrently
graphs below; the uptick in PMI business expectations is also                   increased two and half fold.
revealed, showing the upward trend with the release of later data
points. The driver of growth for the sector has been export-led                 That the industrial sector was able to produce comparable returns
(typically capital goods-producing sectors) but a shift towards                 to the other sectors, however, is indeed remarkable considering
consumer led demand was beginning to occur by the end of                        that manufacturing was one of the hardest hit sectors of the South
2009. Encouragingly for SA is that its export exposure to emerging              African economy.
markets, where private and public debt accumulation are modest,
should on aggregate imply a net positive outlook for exports.                   Values turn the corner
                                                                                For this first time since the early 2000’s for the office sector and
                                                                                indeed for the first time ever in the retail sector, capital value on
                                                                                a per square metre basis fell over the year. The combination of
                                                                                slowing net income growth, high prospects for greatly increased
                                                                                operating costs in coming years and the softening of capitalisa-
                                                                                tion and discount rates has resulted in 2.1% and 2.4% falls in capital
                                                                                value per square metre in retail and office respectively, while
                                                                                industrial values have slowed, as shown in Figure 14 below. The
                                                                                capital value per square metre for retail as at December 2009 was
                                                                                R13,051.0psm; for office R8,446.7psm and for industrial R3,089.2psm.
                                                                                    SOUTH AFRICAN
                                                                                    PROPERTY MARKET
                                                                                    T R EN D S R EPO RT
Fig 14: Capital value per square metre, Rpsm                            Capital flows: spending increases
                                                                        Funds within the IPD database continue to maintain strong
                                                                        investment activity – partly through mergers and fund level ac-
                                                                        quisitions, and partly through continued development activity.
                                                                        For each of the past 15 years, IPD funds have been net investors,
                                                                        although there has been disinvestment at a sector level in some
                                                                        years, particularly in the office and industrial sectors in the late
                                                                        1990s. Figure 16 below shows the net investment/disinvestment by
                                                                        sector for the history of the index.

                                                                        The 2009 total net capital invested of R21.0bn is not only the highest
                                                                        absolute value in the history of the index, it is also the highest as a
                                                                        proportion of starting value. In other words, even with the global
                                                                        issues surrounding debt funding, South African property investors
                                                                        have managed to find the capital to spend on purchases, devel-
                                                                        opments and capital expenditure. The 2009 value is 68% increase
                                                                        on the previous year, with office investment almost triple the 2008

                                                                        At a segment level, city decentralised offices accounted for over
                                                                        20% of the total net invested during the year, followed by inner
                                                                        city offices at 15% and community shopping centres at 10%. It is
                              Source: IPD South African Digest 2009     unsurprising that the majority of investment occurred in Gauteng,
                                                                        however with 60% of total net investment Gauteng certainly
A more detailed picture emerges, however, at a segment level.           received the lion’s share, a higher proportion than in previous years.
Once again within the retail sector the benefits of larger, higher
quality centres is clear as a general rule. Provincial offices boasted   Fig 16: Net investment by sector, Rm
a notable increase in capital values, with inner city offices being
marked down and city decentralised offices remaining steady. All
industrial segments managed to post increases in values, however
as has been noted previously the industrial sector appears to lag
the rest of the market somewhat.

Fig 15: Change in capital value psm 2008-2009, %pa

                                                                                                      Source: IPD South African Digest 2009

                                                                        This relatively high level of capital flows in 2009 perhaps suggests
                                                                        a belief among fund managers that prices in 2009 represented
                                                                        relatively good value, and that yields have indeed flattened.
                                                                        Funds are therefore positioning themselves for a recovery through
                                                                        a countercyclical strategy, taking advantage of the opportunities
                                                                        that presented themselves in the unique circumstances of the past
                              Source: IPD South African Digest 2009     12 months.

Property back where it’s supposed to                                      The IPD Digest is now available for purchase.
be                                                                        The IPD SA Property Investors Digest is a definitive record and the
                                                                          most comprehensive statistical analysis of investment property
The bounce back from a low base in 2008 marked the South                  available in South Africa. Expert commentary is supported by
African equities market as the best performing of the major quoted        tabular analysis in 84 data tables.
asset classes in 2009. Given the greater liquidity and the ability to
reflect price changes almost instantaneously it is not surprising          For more information or to order your copy phone (011) 883 4977
that the sharemarket both moved more rapidly in the downturn              or email
and reacted faster to the recent signs of economic recovery than
direct property is able to.

Listed property funds – both PLSs and PUTs – have been assisted by
the general sharemarket upswing and as such also outperformed
direct property in 2009. Investors moving out of the bond market,
coupled with continued high supply, resulted in weak bond returns
in 2009.

With an 8.7% total return for 2009, direct property is therefore
placed between equities and bonds, which returned 32.1% and
-2.4% respectively. This is a restoration of the theoretically correct
position – based on risk profiles – after a brief reversal in 2008. Over
a three and five year period, however, direct property has outper-
formed both bonds and equities, highlighting the true strength of
the South African property market in recent years.

Fig 17: Comparative total returns, % pa

 Source: IPD South African Digest 2009, JSE via Ecowin, JP Morgan
                                                        via Ecowin

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