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Financial pressure supports expectation of further rise in commercial vacancy rates

‘I expect a sort of 7% average depreciation in values this year, and another 9% next year’: John Loos – FNB commercial property strategist.

NOMPU SIZIBA: The FNB Commercial Property Finance 2021 Market Outlook report suggests that higher commercial property vacancy rates are likely to be the reality for the next couple of years, given that it’s expected that it will take some time before gross domestic product levels reach what they were prior to Covid-19 hitting our shores. And even then the sector was already under pressure.

Well, to flesh out the issues for us, I’m joined on the line by John Loos. He’s a property strategist at FNB Commercial. Thank you so much for joining us, John. You’re forecasting that the all-property vacancy rate will be at 8% for this year. It would then jump to 11% in 2021 and a whopping 13% in 2022. So you see things getting much worse before they get better, even though the economy is expected to grow in the next year and beyond?

JOHN LOOS: Yes, Nompu. I think where people can be fooled is they look at forecasted growth rates – and we expect 3.3% GDP growth next year, after ‑8% this year. And the problem at minus-eight is that, even if you get 3.3% off that, you’re not getting back to the GDP level in a hurry that you had in 2019. And in 2019 you already didn’t have enough GDP to drive enough commercial property-space demand to stem the tide of rising vacancies. They were already rising then.

So, if you go back, if you start growing but you stay at a GDP level below that of 2019, which we’re forecasting, then I would suggest that there’s even less overall demand for commercial property space in all likelihood, and a continuation of the rising vacancy rates, possibly even at a faster rate.

NOMPU SIZIBA: So, given what you say, what then is the forecast for rentals and the ability of property owners to get escalations?

JOHN LOOS: Well, the income knock may not be as severe as what it might turn out to be this year, because of that severe lockdown rental-income knock where a lot of tenants had no income and got some sort of payment relief, or couldn’t pay. TPN [TPN Credit Bureau] data shows us that that was quite severe.

Going forward, it might not be as severe as that, but income on property will still be under pressure, we believe, from declining market rentals in a rising vacancy situation. So it stays under pressure and therefore continues the property-value correction into next year.

NOMPU SIZIBA: When you dissect the commercial property sector in terms of office, retail and industrial, which segments appear to be most under pressure?

JOHN LOOS: I think the big three – if you take smaller ones as well as I think hotels and leisure. But, given the severity of the lockdowns on them and probably the wariness of the limits on foreign tourists coming in and so on, if you take the big three – retail, industrial and office space – I think that the two which will be fighting it out to be the weakest will be office and retail.

Now, online retail does challenge retail. Remote working challenges office. Both obviously are challenged by a severely weak economy.

I think that it’s a tough call. The one thing that is also against retail is that its affordability has deteriorated far more over the past two-and-a-half decades – far more extreme rental inflation, operating-cost inflation and inflation in values in retail property – than was the case in industrial and office space. So that’s what counts against retail, along with the weak consumer;  and weak demand will count against office space. I think those two challenge each other quite closely for, let’s call it, the wooden spoon, the weaker sectors.

Industrial, I think, is in a better space, less challenged by technology. Not entirely unchallenged, but less challenged. And it’s the most affordable form of property, as well. So less pressure on the tenant population from its high rentals, as would be the case in retail.

NOMPU SIZIBA: Given the dynamics in the commercial property space, are we likely to see a depression in property prices? And perhaps, for your more opportunistic investors, this may be an ideal time for them to take advantage of lower property prices, given the lower interest-rate environment, as well?

JOHN LOOS: I think so. I think that it’s become a significantly better investment opportunity. We’ve already seen noticeable value deflation this year to date. I expect a sort of 7% average depreciation in values this year, and then another 9% next year. So, when all is said and done, possibly close to 15% over a two-year period. That does make it, I guess, that much more attractive and for investing in Reits [real estate investment trusts] as well, the listed property sector.

We’ve had a massive correction in the list of index Reits. I think there was about a 20% correction prior to this year already, and a big 50% drop since the beginning of this year to date.

So even that has become a better sort of opportunity – if Reits are what tickles your fancy – than was the case previously.

NOMPU SIZIBA: Yes. In terms of that, investing in Reits, we had a Nesan Nair of Sasfin Securities speaking to us earlier, and he was saying that he would steer clear for now. I know that you don’t normally speak in a capacity as a market analyst, but you are au fait with it. What are your thoughts about it, because you understand the economics? If you’re investing for the long haul, is it an area that you would invest in?

JOHN LOOS: Well, I never give people advice and said “buy”  or “don’t buy”. But, given the massive correction that they’ve had, I think it certainly is a better investment opportunity than a few years ago. A few years ago I was suggesting to certain people that this thing was over-heated, and that that wouldn’t be the time to invest – whereas now, [with them] trading below their net asset value in many cases, it is a lot better.

It’s tough to say where the bottom is.

You never see the bottom until afterwards. And of course, because it might be a better buying opportunity, I don’t think they’re going to perform wonderfully in the near term. I think it’s going to take a few years before they start picking up speed. The first thing that will have to happen is for those physical property values underpinning the Reits to correct, and correct a lot more slowly. So I think there’s a process. But that’s where we are at the moment.

NOMPU SIZIBA: John, thank you so much for your time, as always. John Loos is a property strategist at FNB Commercial.

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