Commercial property activity subdued with vacancy rates rising in a buyer's market

Concerns related to Covid-19 and its impact on commercial property, remain strong. 

Subdued commercial property rental activity could create downward pressure on rentals and even a decline in average property values.The latest FNB Property Broker Survey is forecasting a projected -7% value decline for all commercial property values in 2020.The component of the survey relating to the buying and selling market for commercial property indicates brokers perceive an oversupply.

Commercial property rental activity levels in South Africa are currently still significantly below levels seen in the first quarter of the year before the coronavirus lockdown, and vacancy rates are rising, according to the latest latest FNB Property Broker Survey.

Commercial property spans retail, industrial locations and offices.

This could create downward pressure on rentals in all three of these market segments and, consequently, a decline in average property values in the near term, according to the survey. FNB is forecasting a projected -7% value decline for all commercial property values in 2020.

SA's economic activity has been hit hard by a nationwide lockdown imposed at the end of March to stem the spread of the coronavirus, leading to a plunge in business confidence and layoffs. While the lockdown has eased, some experts claim the SA economy is experiencing its worst recession in 90 years.

Second quarter GDP figures show a -16.4% contraction on a non-annualised basis, while the SA Reserve Bank recently revised its growth outlook from -7.3% to -8.2%.

Multiple concerns

A sample of commercial property brokers in and around the Greater Johannesburg, Tshwane, Ethekwini, Cape Town and Nelson Mandela Bay were surveyed for the FNB survey. Brokers surveyed in the third quarter perceived a slight strengthening in industrial and retail rental market activity levels compared to the second quarter, but a slight decline in the office market activity level.

Concerns related to Covid-19 and its impact on property remain strong. Regarding office rental, the biggest concern appears to be how companies might revise their office space needs as remote working increases.

Brokers expect the retail rental market to likely weaken over the near term and, apart from online retail, their biggest concern on average is the negative economic impact from Covid-19 lockdowns on the economy and the consumer.

The Momentum/Unisa Consumer Financial Vulnerability Index (CFVI), for example, has declined to its lowest level ever during the second quarter of 2020.

Tenant performance

TPN (the credit bureau which vets tenants for rental purposes) reported tenant payment performance, dipping sharply during the second quarter lockdown period. From 77.85% of tenants being in good standing with landlords regarding rental payments in the first quarter of 2020, performance of commercial tenants dropped sharply to 50.36% in the second quarter.

"This indicates a sharp deterioration in the finances of tenants in the second quarter lockdown period, resulting in the likely closure or scaling back of a noticeable group of tenants' businesses," according to the FNB report.

"Rising vacancy rates may support this notion of decline in production capacity in especially manufacturing (strongly linked to industrial property), retail (linked to retail property) and certain services sectors linked to office property."

About 28% of respondents expect small business demand for space and the relative affordability of industrial property as an advantage over the other property sectors, while 9% point to increased need for warehouse space as online retail grows.

Short-term leasing

"Tenants' needs are evolving, and while the Covid-19 pandemic has certainly accelerated the demand for greater flexibility, the shift towards tenant-driven commercial real estate was already gaining traction before lockdown restrictions were imposed," comments Inospace CEO Rael Levitt.

“While the demand for short-term leasing has been present for a while, the coronavirus pandemic prompted us to incorporate our flexible rental model of micro-industrial and office spaces into bigger and bigger commercial leases."

Since Inospace introduced a flexible lease option in March this year, they have seen a significant spike in the demand for very short lease terms.

"In fact, Inospace signed more leases in June and July during lockdown than it did last year, which highlights businesses’ desire for flexible arrangements," said Levitt.

Kagiso Mahlangu, a director in the property law division at global law firm, CMS South Africa notes that the office sector has definitely borne the brunt of the negative impact of Covid-19, but comments that "the industrial property sector has not been as badly affected".

Mahlangu has seen plenty of activity in the industrial sector, specifically as regards warehousing.

"E-commerce took off in a big way during lockdown," she explains, confirming the findings of a recent Nielsen survey that showed that close to 40% of South African consumers are now shopping more online.

Fourfold impact of Covid-19 on SA commercial property industry

Commercial property sales

The component of the survey relating to the demand-supply balance in the buying and selling market for commercial property indicates brokers tending to feel there was an oversupply in the second and third quarters of the year.

This type of sentiment actually started since early-2019, according to John Loos, property sector strategist at FNB Commercial Property Finance. It is now more pronounced all three markets – retail, office and industrial - show significant oversupplies of property relative to demand.

The survey shows financial pressure to still be by far the biggest single driver when it comes to sales. Other motives listed include "relocating to be closer to the business' particular market", "looking for a location with better access to transport, logistics and commuter nodes", and downscaling due to financial pressure.

Maybe hold on?

As tempting as it may be to sell a business' property for liquidity purposes, now might not be the best time to sell, according to Shane Padayachy, property investments area manager at Business Partners Limited, financiers for formal small and medium owner-managed businesses.

He admits the SA commercial property sector has taken a significant knock in the midst of the Covid-19 crisis.

"Without a doubt, the office market has taken the biggest hit – with so many people realising during lockdown that they can work from home – followed by the retail market to a lesser extent, having been impacted by the increased uptake in online shopping," he says.

"While the industrial market was affected during the initial 'hard' lockdown, many companies in this sector were allowed to resume operations quite early on, making this the most resilient of the commercial property subsectors."

Despite the different sectors of commercial property being impacted to varying degrees, Padayachy sayst the overall market impact has not been good – from a sellers' perspective, at least. Given the current socio-economic climate, it is more of a buyers' market right now.

"That being said, good properties in prime locations are very hard to come by and, as a result, these properties will always be in a sellers' market, as there will always be willing buyers," he notes.

For business owners whose property does not fall within this sought-after market, however, Padayachy warns against selling right now, and suggests looking into alternative arrangements if possible.

Possible alternatives

"This is not the right time to be selling your business property, so if possible, business owners should try and retain the property until the market turns to ensure they attain their full value," he suggests.

"If the business is suffering, consider downscaling operations and moving to a smaller property, and get a tenant in to your original premises to cover the loan repayments and avoid selling. Whereas if the reason for selling is due to high gearing, there are a lot of financial institutions or silent investors that could get involved to reduce the gearing, while avoiding a sale. There is then always the option to buy back this share at a later point, should the business owner want to."

While the overall market may take some time to recover – Padayachy predicts around 18 months – he says that an eventual recovery is inevitable.

"Commercial property is likely to remain a buyers' market for the majority of 2021. While the industrial market may make a full recovery before then, the office sector may only recover towards the end of 2022," he estimates.