In each of the three commercial property sectors – office, industrial and retail – vacancy rates have fallen considerably and are currently at historically low levels. And this doesn’t look like it will change any time soon.
“There are enormous constraints in construction at present,” says John Loos, property strategist at FNB Commercial Banking, “so I expect these vacancy rates to remain low for many years to come. This implies that rental incomes will rise considerably in future.”
There are huge infrastructure projects currently being undertaken, some for the 2010 World Cup, others not. The commercial property sector must compete with these projects for resources, both materials and skills, and this is leading to a supply-side crunch. Building and construction inflation is widely expected to outpace other inflation rates over the next five years. This will feed into higher rentals and therefore very good returns for the property industry.
Michael Levin, a senior investment manager at Cannon Asset Managers, agrees. “With rising building costs and input shortages, developers will be less inclined to embark on new projects,” he says. “This will, in turn, aggravate the already limited supply of space.”
Vacancy rates in each of the sectors have declined markedly over the past four or five years, as can be seen in the table below:
Source: Investment Property Databank
Although all the sectors have low vacancies at present, the level for offices is somewhat higher than the other two. As Levin points out, this implies that the office market has the greatest scope for growth in the near to medium term, assuming that all other things remain the same.
Of interest, the total return from the office sector during 2006 lagged that of both retail and industrial space, something which has baffled market commentators. The industrial sector returned 31,1% during 2006, the retail sector saw a return of 27,4%, while the office sector return was somewhat lower at 24,5%.
The capital growth in office properties was below that of the other two, although the office sector still had relatively strong net income growth. Indeed, income growth was above that of the retail and industrial sectors. This income growth is not flowing through into revaluations and the office sector did not experience a rerating in 2006. This would indicate that valuers were conservative in their 2006 valuations, thus providing a further reason to expect the office sector to outperform its counterparts in the near term.
Levin notes that “the fundamentals are excellent for the property industry as a whole. Interest rates are stable and the economy is in a healthy state, so the outlook is positive. It is really a matter of degree and, on balance, the office sector is tipped to see above average returns this year.”
According to Mike Schussler, an economist, there is a movement away from residential to commercial property in general. “Within commercial, I believe that industrial property is the next big thing as a result of capacity constraints in manufacturing and warehousing etc., but small office blocks are also a good place to be. Retail, like residential, may be overdone, except in new areas and townships, but long term growth for all property will be positive.”
According to Christopher Hart, a senior economist/strategist at Absa, the South African economy has experienced an economic growth shift, ie from a consumption-led boom to investment-led boom.
“Strong profit generation, strong economic growth and interest rate stability are expected to drive the economy. The commodity boom and the infrastructure roll out will be further drivers of the economy. Consumers, business and government all have considerable capacity to increase credit levels. The growth cycle does not appear to have reached the stage of diminishing returns, which still suggest that there are a number of years before exhaustion of the current phase,” he says.
“What does the growth shift toward investment mean for the South African economy? When it comes to credit, consumption components are now trending down and investment components rising. When it comes to vehicles, passenger vehicle sales are leading the slowdown while commercial vehicle sales remain strong. When it comes to property, commercial and industry property is now strengthening. And when it comes to trade, the growth in the trade deficit is a result of increased imports of capital goods.” – Kara Michaels