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Market rentals showing impact of tougher economic times

Monday, April 19, 2010

The effect of the economic downturn on market rentals has now become strikingly evident.

According to the latest Rode’s Report on the SA Property Market, in the fourth quarter of 2009 the overall growth in market rentals for office space was weak. This was especially evident in Cape Town (-6%) and Johannesburg (-4%) decentralized, where rentals were, on average, lower than what they were a year ago. But, this comes as no surprise in light of the faster northward march of prime-office vacancies in these two decentralized regions.

Even on the industrial front, nominal rentals have continued to shrink – despite the upward movement in the fourth quarter of 2009 in manufacturing output and capacity utilization. The Central Witwatersrand, Durban, Port Elizabeth and the Cape Peninsula all registered lower nominal rentals than a year earlier. “However,” notes Rode, “because building-cost inflation has actually declined by 9%, we have the anomalous situation that real rentals have actually shown positive growth.”

Flat rentals also remained stagnant for the most part. While Durban mustered a growth of 4%, Johannesburg, Pretoria and Cape Town showed rentals roughly at the same level of a year ago. Port Elizabeth showed the poorest performance as rentals contracted by 2%.

Comments Rode: “This stagnation is indicative of the financial stress being experienced by both incumbent and prospective flat tenants. Usually, during tough economic times, ‘doubling up’ occurs on a large scale, keeping the demand for rental residential space in check.” An example of doubling up is children moving in with their parents.

After weakening during 2008, owing to uncertain economic conditions both locally and abroad, capitalization rates finally turned the corner in the first quarter of 2009, heading marginally south and sideways once again.

“However”, adds Rode, ”given the poor performance of market rentals, the principal risk to the outlook for capitalization rates remains the scaled-down expectations regarding the direction of real rentals. This, potentially, could lead to property investors requiring higher income returns from property because of lower capital-return prospects.”

Please note: Capitalization rates are the property equivalent of the forward earnings yield of shares; this implies that declining capitalization rates result in rising market values, and vice versa.

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