Real Estate Investor Magazine South Africa May/ June 2020 | Page 32
INVESTOR INTELLIGENCE
When the Covid
clouds clear
Look into the future of the commercial
property market
As the globe grapples with the humanitarian crisis around
the pandemic, with a ripple effect across all sectors of the
economy, much is being said about the effects of Covid-19
on the commercial property market in South Africa including
pressing landlord and tenant issues.
“F
rom a long-term investor perspective,” says
Andrew Jefferson, a director of Annenberg
Property Group, “Property needs to be viewed as
a long-term investment, with decisions made looking to
the future. So how do we see the future playing out in the
commercial property market?”
Rental rates will decrease
Jefferson says the starting point in a decision to acquire a
commercial property investment should always begin with
the bricks and mortar price. “A lease may last for a few years,
but rental rates will always revert to market in the long run.
We therefore need to understand what the current market
related levels are before making a decision to buy.
“Rental rates will drop post the Covid-19 lockdown. In
a rental market controlled by supply and demand, when
supply increases and demand decreases, the price has to
capitulate. Companies will revise their growth plans, look
to consolidate or look to move. Many businesses will cease
to exist in the medium term, even if they are able to survive
for the next few months. Tenants will be forced to move out
of their premises, even if they are in the middle of a lease,
and as a result, vacancies will rise.
“This high level of vacancies in the commercial sector
will create competition amongst landlords to fill their
vacancies. The end result of this is always a drop in rentals.
We have already seen how the listed sector has reduced
their rental levels significantly in order to retain tenants in
good standing.
“We have always seen the strength of the commercial
market like the ocean tide - as the market strengthens,
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MAY/JUNE 2020 SA Real Estate Investor Magazine
the high tide pushes demand into secondary areas as core
areas have few vacancies and prices become unaffordable.
As the tide weakens, that demand results in the opposite
- rising vacancies are first filled in the core areas, leaving
secondary areas particularly vulnerable to high vacancy
rates. The effect of this means that rental levels will see a
bigger drop in outlying areas than in primary areas, which
comes back to the ever-critical importance of location.”
“In a rental market
controlled by supply and
demand, when supply
increases and demand
decreases, the price has to
capitulate.”
Yields
Jefferson says yield is a little less obvious as an investors'
required yield is a function of many criteria. “On the macro
side, we will see the yield move significantly higher as the
current risks are significantly elevated, due not only to the
weak economy, but also the fear of the unknown. If we
knew how the pandemic will play out, we could eliminate
much of the short-term noise. But we don't know how
bad things are going to get, and as such the fear of the
unknown will further increase yields.
“We have always seen the
strength of the commercial
market like the ocean tide - as
the market strengthens, the
high tide pushes demand into
secondary areas .”
“Commercial property yields are seen to be correlated with
bond yields. In the past few weeks, we have watched as the
10-year bond has risen from under a 9% yield to above 12%,
but recently settled just under the 11% level, thanks to the
SA Reserve Bank stepping in to buy bonds in the secondary
market. We expect similar, but less drastic movements in the
commercial property market yield.
“Yields are also determined by a tenant's covenant (a
stronger tenant means a lower risk profile, hence lower
required yield), location of the property (core areas demand
lower yields), property type (the retail and office markets will
be worse hit than industrial and logistics), length of remaining
leases and diversion of rental levels from the mean (if the
rental level is above market you can expect significant rental
reversions and this needs to be factored into the yield).
“However, yields are also correlated to the interest rate. We
have recently seen a reduction in the prime rate from 9.75%
to 7.75% and expect further reductions in the next several
months of around 100bps or potentially more. Investors of
good standing are achieving rates of around 0.5% below
prime - some even more favourable than this. This means in
the near future they will be borrowing at below 7%.”
To illustrate how this will affect an investment, Jefferson
cites the following example:
A property before Covid-19 achieving a net annual income
of R1 million, valued at a 10% yield was worth R10 million.
The simple interest paid on this R10 million was R975 000 per
year at prime. Post Covid-19 the same R10 million at prime
would cost the investor R775 000 annually in simple interest,
effectively increasing their net cash position by 20.5%, or
more if we look at the effects of compound interest and even
more if the interest rate falls further.
“So, while we definitely see the required yield on a property
increasing by 1%-1.5% to account for increased risk and future
rental reductions, we don't foresee this blowing out by the
same level as the bond yield.”
Where to from here?
“As property investors, we have been trained to think long-
term, to drown out the noise, to look for opportunities and
to find solutions to problems. We understand that these are
incredibly trying times and both investors and tenants have
frayed nerves. The next few months are going to be incredibly
tough and you are going to need the best advice and team to
help guide you,” concludes Jefferson.
SOURCE Annenberg Property Group
SA Real Estate Investor Magazine MAY/JUNE 2020
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