These types of offices will lead South Africa’s commercial sector out of its slump: property expert

 ·5 Sep 2022

Recent developments in the area of inflation and interest rates have in many ways resembled the environment leading us into the Global Financial Crisis (GFC) in 2008/9, says John Loos, property sector strategist at FNB Commercial Property Finance.

The recent inflation surge has been driven largely by the two same variables that drove the GFC period’s inflation surge: oil and food price inflation surges.

While the recent consumer inflation surge and interest rate hiking cycle don’t appear as yet to be nearly as severe as the one leading us into the GFC recession, the big difference between now and back then has been the build-up to each one, said Loos.

“Whereas the GFC was preceded by a few years of above 5% economic and real household disposable income growth, the current period has been preceded by almost a decade of economic growth stagnation, and then a 2020 lockdown contraction of major proportions.”

Even in 2019, the year prior to lockdowns, the economy only managed a slight 0.1% positive growth rate, while real household consumption expenditure managed a slightly stronger 1.1%. Then came the big 2020 dip, with real consumption expenditure dropping by 6.5%, and the 2021 rebound not yet even bringing it back to the 2019 level, said Loos.

This translates to a far more pressured financial environment for consumers, retail tenants and retail landlords alike than the strong growth years preceding the GFC. “And there is indeed evidence that consumer confidence is far weaker this time around,” he said.

A further change from the GFC period is retail property operating costs.

“Very big municipal and utility tariff increases have been introduced in the period since the GFC, these being a major contributor to the rise in gross operating cost/gross income receivable percentage. This percentage was 30.7% in 2007 prior to the GFC. Just prior to the recent inflation and interest rate hiking surge this time around, this percentage was a significantly higher 42%,” said Loos.

All round retail property affordability in the years building up to the current rate hiking period was significantly worse than prior to the GFC, too, he said.

“To date, the most recent rise in inflation and interest rates doesn’t look set to be as severe as the GFC period, which included a double-digit inflation peak and 500 basis points’ worth of interest rate hikes, compared with the recent 200 basis points to date and a further 125 basis points anticipated as inflation looks to be near its peak,” said Loos.

But the conditions during the build-up to the current events have been far worse this time around than was the case pre-GFC.

Commercial slump

Commercial real estate market indices have been in such a protracted slump that investors are failing to see the long-term growth potential created by the sector’s downturn, noted High Street Auctions director Greg Dart.

Post-pandemic social and economic activity, he pointed out, only began to normalise this year.

“We need to start viewing commercial real estate investment in terms of where demand is likely to be in three to five years’ time, rather than obsessing over quarterly statistics, and we have a fair number of data points and emergent trends on which to base predictions.

“In the post-pandemic negative column, we have economic shrinkage, an office vacancy backlog to fill, and an as-yet-unknown percentage of the workforce that will continue to work remotely or in a hybrid model,” he said.

Two factors that will give commercial real estate substantial impetus towards equilibrium, however, are the growing number of older commercial buildings earmarked for residential conversion, coupled with the massive decrease in new commercial builds.

“According to StatsSA’s Q2 2022 data, office space planning and completions remain the weakest of overall commercial building levels, declining by 50.1% year-on-year in Q2, following a 43.9% decline in Q1. For the twelve months to June 2022, square meterage of office space plans declined year-on-year by 50.14%.

“Plans passed for the twelve months to June 2022 remain 69.9% down on the twelve months to June 2019 and 74.2% down on the twelve months to June 2018,” said Dart.

It’s likely, given those numbers, that within five years, as economic activity builds to pre-pandemic levels, we’ll see office vacancies drop by at least 10%.

“Demand will be at the upper end of the market, where corporates will be seeking very specific types of office space. And investors who can meet that demand are going to cash in handsomely.”

Future office space

Dart said office spaces going forward will:

  • Be in central hubs close to shopping and transport amenities;
  • Be light and modern; and
  • Offer indoor and outdoor work and recreation areas.

“But the biggest winners in the commercial space will be those investors who transform interiors to suit corporate needs going forward, which means doing away with cubicle floor layouts.

“Owners should be thinking of spaces tailored to hybrid workforces. Open plan offices will always be around, but the modern trend is for these to be spread out with a hot desk system in mind, more green architecture and break-away communal discussion spaces.

The most important trend changes, however, come with the incorporation of several mini meeting rooms with superior AV technology to accommodate meetings with remote staff and clients, as well as sound-proof office pods, he said.

“With widespread movement toward versatile, welcoming office spaces, there’s an emphasis on creating mini environments that can inspire focus – the same focus that people became accustomed to when they worked at home. In that context, the benefits of sound-proof work pods have become increasingly popular.”

He said that single-person ‘hot desk’ style pods help to facilitate concentration in an open-plan office and commercial buildings offering these amenities will attract higher rental income than traditional office spaces.”

“No market remains flat forever and the time to buy is when it is low; not at its peak. Auctions set market value in the most transparent way, which is why so many funds transact through us. It makes financial sense.”

Read: This segment of the property market consistently outperforms in South Africa

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