An analyst discusses the performance of the real estate market in times of high inflation
The South African property sector has benefited from higher inflation, although some sectors are still struggling with the impact of a post-Covid market. A startling revelation, but that’s exactly what Madibana Letsoalo, listed real estate equity analyst at Momentum Investments, confirmed.
In a recent webinar, Letsoalo said that the downward trend in escalations, along with negative reversals in the frontier market, has put some pressure on base rent growth in the current environment of rising inflation relative to historical periods.
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Along with that, she said direct property costs have outpaced inflation growth, with rates and taxes, for example, rising 341% on a cumulative basis since 2006.
“It definitely put pressure on the growth of net property income,” Letsoalo said.
That said, Letsoalo noted that, since the early 2000s, direct ownership has provided total returns of 13.8% on average compared to the average inflation rate of 5.5%.
Property income has consistently averaged 9% over this period, while capital returns have not been able to keep up with long-term inflation.
Capital returns turned negative in 2019 and were further exacerbated by the impact on property values during the pandemic.
“We have started to see hollow valuations in some of the listed property companies, although some sectors such as the office market may continue to see falling valuations in the short to medium term,” she said.
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Letsoalo explained that listed real estate, on the other hand, has outperformed direct real estate since 2002, achieving total returns of 16.1% and real returns of 10.6%.
“Over the past 20 years, the sector has only experienced four periods of negative real returns, including since the start of 2022. Until the end of 2019, listed real estate has consistently outperformed bonds , cash and equities, having only underperformed the equity market in the wake of Covid-19, as real estate companies were among the hardest hit stocks in the market.
“There is no doubt that an environment of high inflation and high interest rates is likely to add pressure to the consumer’s wallet,” Letsoalo said.
She said this is especially true for low-to-middle income people, who spend about 25% of their income on non-discretionary items such as food and personal care.
“Consumers will likely start shopping down the value curve and we’ll potentially see smaller basket sizes with a smaller proportion of the consumer’s budget to discretionary spending,” she said.
Letsoalo added that investors continue to favor convenience malls with a higher proportion of essential services as well as rural and township and township centers exposed to value brands over larger malls.
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With shopping numbers improving and footfall returning to these centers after the lockdown restrictions, she notes that larger shopping centers are making a comeback.
In the office market, Letsoalo said vacancy rates remained stable at 16.7% in the second quarter of the year, after rising sharply from the pre-Covid level of 11% in December 2019.
“That equates to about 1.1 million square meters that have been vacated in the last two and a half years,” Letsoalo said.
“The high vacancy rate continues to put pressure on office rentals as the sector struggles with oversupply and very little new demand for office space.”
She said green office space generally outperforms non-certified prime and Grade A offices on all metrics measured by the Green Buildings Council of South Africa.
“Green building vacancies exceeded their counterparts by 70 basis points, indicating tenant interest in green buildings.”
From a development activity perspective, Letsoalo has seen construction cost inflation also increase significantly in the current cost environment, having increased by 12.9% year-on-year in April 2022.
“This is likely to keep development activity at bay, limiting new developments coming to market in a surplus sector such as the office and retail market.”
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Industrial developments are still in the start-up phase, with some landlords able to pass on construction increases to their tenants.
“Favorable supply and demand dynamics in the rental market should drive rental growth going forward.”
Overall, Letsoalo said the property’s windshield is definitely getting a lot clearer.
“A year or two ago, the sector was marred by a lot of uncertainty. Having been through one of the most challenging operating environments in the history of the real estate industry, we believe earnings have bottomed out and expect earnings to pick up going forward,” she concluded.