By John Loos
It’s that time again, early in the new year when we are speculating as to what 2022 may hold, in this case for the property part of the South African economy.
In a still-weak, albeit improved, economy with rising interest rates, property market fireworks don’t appear to be on the cards this year. But there are some expected “relative” positives.
Here are the 10 key themes we think will be worth looking out for:
1. Rising trend in All Property Vacancy Rate expected to continue in 2022
The MSCI All Commercial Property Vacancy Rate has been on a broad multi-year rising trend, from a low of 4.3 percent as at the second half of 2015 to 9.7 percent by the first half of 2021. We would expect this rate to move into double-digit territory in 2022, if it has not already during the second half of 2021.
After a sharp -6.4 percent decline in real GDP in 2020, the level of economy-wide output is believed to have only partially recovered back to 2019 levels, with a +4.7 percent growth expectation for 2021 being insufficient to fully revive the output level.
2. Rising interest rates expected to sustain multi-year broad rising trend in capitalisation rates
Domestically, the CPI (Consumer Price Index) inflation rate rose through much of 2021 from 2.9 percent year-on-year as of February last year to 5.5 percent by November, with petrol and food prices being key influencing factors.
This took the CPI inflation rate up to near to the 3-6 percent upper target limit of the SARB, which responded by raising interest rates by 25 basis points in November 2021. Three more such 25-basis point interest rate hikes are expected in 2022, taking prime rate from its current 7.25 percent level to 8 percent by year end.
The expectation of a further rise in the Government debt-to-GDP ratio, with state finance under ongoing pressure along with short term interest rate hiking, is expected to exert upward pressure on long bond yields and therefore, property capitalization (cap) rates in 2022, with cap rates being a source of downward pressure on real commercial property values.
From a decade-low monthly average of 6.9 percent in May 2013, the monthly average long bond yield ended the year 2021 at 3 percentage points higher at 9.9 percent, and the broad rising trend is expected to continue in 2022.
3. Average capital value per square metre on commercial property is expected to stop falling in nominal terms in 2022
We expect that actual ‘nominal’ average capital values on commercial property will at least halt their decline in recent years, moving back into single-digit positive territory in 2022.
However, rising cap rates and weak net operating income growth is expected to keep average capital values in “real” declining territory. The multi-year correction in property values is thus in effect expected to continue in 2022, albeit at a slower pace and in real terms only.
How far are we into the multi-year correction in real property values?
Since the second half of 2018, average capital value per square metre had declined by -9.5 percent as at the first half of 2021, according to MSCI data. Nine out of 11 semesters from 2016 to the first half of 2021 have shown real (GDP inflation-adjusted) decline in average values when compared with the preceding semester.
So, while actual valuations have dropped far less, in real terms (the proper way to assess a correction) the cumulative decline in the MSCI All Property Average Capital Value has been a significant -29 percent from the first half of 2016 to the first half of 2021.
4. Hotel property market expected to improve in 2022
Firstly, a large portion of demand for hotel rooms is non-essential in nature, and with many businesses and households financially pressured in the aftermath of the major 2020 recession, many will continue to put travel and hotel stays on the back burner.
Secondly, given the successful “zoomification” of much business interaction during the lockdown period, a portion of business travel that used to take place prior to Covid-19 is likely not to return.
Thirdly, South Africa has been plagued by limitations on foreign travellers to the country. Vaccine rollout is key to improving this situation.
All three of these challenges are expected to be in part alleviated in 2022, enabling an improved hotel property market year. But insufficient to end this class’ under performing of the ‘big three’ commercial property classes. By October 2021, the average hotel occupancy rate had risen to only 31.6 percent from 18.8 percent in October 2020, which was still far below the 52.8 percent of October 2019, while total hotel income for October 2021 was still 32.9 percent down from October 2019.
5. More employees are expected to work from the office in 2022
The office property class is expected to be the under performer of the three major commercial property classes in 2022, with its already high average national vacancy rate of 17.9 percent (according to MSCI data) as at the first half of 2021, expected to rise further.
The work-from-home surge is a key dampener of demand for office space. We believe the level of full-time office work will not go back to the same levels as before the lockdowns.
Other sources of pressure on demand for office space are the normal recession effect, which caused a major drop in employment numbers in the office-bound sectors of the economy and the improved utilisation of desk space seems to have picked up speed of late, with ’hotelling’ of desk space increasing in popularity. Hotelling refers to a desk booking system.
Partly offsetting this are social distancing measures in the office, which often require companies to have lower density workspaces. But we believe that this is only a partial offset of the above, leaving the office market under pressure in 2022 with its average vacancy rate rising further.
6. Retail was better in 2021 than in 2020, but further improvement likely to be harder going into 2022
Retail property performance improved in 2021, but 2022 will see further improvement. Real Household Disposable Income is projected to grow further, at a rate of +0.2 percent in 2022, following a +2.8 percent growth rate in 2021. Real disposable income growth is expected to be constrained by very weak employment growth.
Slightly higher average consumer inflation in 2022, compared with 2021, is expected, and forecast hikes in interest rates on outstanding debt would eat into disposable income further.
On top of this, the effective tax rate on households is expected to continue, with adjustments for wage inflation-related tax bracket creep being only partial. We expect retail centres to be focused more on high frequency essentials, and less on luxury and low frequency purchases, to outperform.
7. Industrial property market to remain the out performer
We expect the industrial property market to remain the relative out performer of the major commercial property classes. It is the most affordable of the three classes, and the most adaptable. In addition, it appears set to benefit in the coming years from increased online retail focus.
The FNB Commercial Property Broker Surveys of recent quarters have shown the Industrial Market to indeed have been the strongest one through 2021, and the only one of the three markets where brokers perceive the average vacancy rate to be in significant decline.
8. Residential rental market is expected to see better times
2022 is expected to see some strengthening in the residential rental market. We know already from TPN tenant data that the percentage of tenants in good standing with their property owners regarding rental payments has recovered markedly following the 2020 lockdown dip.
TPN’s national average vacancy estimate has declined from a peak 13.31percent in the first quarter of 2021 to 10.66 percent by the third quarter, and average rental inflation increased mildly to +0.4 year-on-year in the third quarter after having dipped into moderate negative territory in prior quarters.
A decline in vacancies would provide mild support for something of a rental inflation recovery, early hints of which we have already seen.
We would expect a mild recovery in the residential rental market in 2022 because of our expectation of further moderate interest rate hikes. Interest rate hikes typically curb the first-time buyer rush to buy homes that interest rate cutting brought from 2020 onward; that rate cut-driven buyer demand surge having helped to leave a “gaping hole” in the rental market.
9. Residential development market to peak
Despite the residential rental market expected to pick up moderately, it will likely still be well-supplied for 2022 at least. In addition, expected rising interest rates should likely cool home buyer demand.
This leads to our expectation that we should see the number of residential units plans pass a peak in the near term in 2022, and residential completions to follow suit with a mild lag. 2022 is thus expected to see the most recent “mini-surge” in residential building activity peak.
10. Western Cape Region to be the out performer economically and property-wise
The Western Cape province could be the out performer in 2022. We base this expectation on the belief that the Western Cape’s ability to attract 'semi-grant skills and purchasing power', crucial for economic growth, has recently been enhanced.
In 2021, the unrest and looting in KZN and Gauteng may have further enhanced the relative appeal of living and doing business in the Western Cape, a province that escaped that event.
John Loos is the Property Sector Strategist at FNB Commercial.
*The views expressed here are not necessarily those of IOL or of title sites.
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