BUSINESS BEYOND COVID-19
RICK DE SOUSA: Property owners must repurpose assets to avoid indefinite vacancies
The commercial property market is not broad-based, and that needs to change
In the Business Beyond Covid series, CEOs and other business leaders and experts in their sectors look to the future after Covid-19. What effect has the pandemic and resulting lockdown had on their industries and the SA economy as a whole? Which parts will bounce back first and which will never be the same again? Most importantly, they try to answer the question: where to from here?
Historically, and despite the odds, property is an asset class that has always managed to beat the market. Having worked in the commercial property sector for many years let me state that we will come through this, and the sector will recover from the significant knocks its faced recently as a result of the Covid-19 pandemic.
As many offices, shops, warehouses and other commercial properties sit completely closed because of the unprecedented Covid-19 shutdown, the lockdown has compounded the industry’s challenges into a stark reality: rental collections are down, financing arrangements are being restructured at a rate not seen before, and the present economic outlook is so dim that it’s sure to worry anyone with capital to invest.
The pandemic has come to an economy that was, even before the Covid-19 lockdown, trading at levels last seen more than a decade ago following the 2008 global financial crisis. It’s easy to be worried, if not terrified. It might be hard for us to think back to a pre-Covid-19 world as we all hunker down in our houses, but if we’re honest the SA economy was already in dire straits long before Covid-19 wreaked havoc.
International studies have suggested that cap rates are under pressure to increase by 50 bps, and some large financial institutions such as FNB reported that commercial property growth in real terms, before Covid-19, was flat (slightly negative in the case of office) and that upwards risk adjustments were required even pre Covid-19. I estimate that between 15% and 20% of rental income will be lost, on average, over a three-year period, as a result of Covid-19, economic downgrades, a likely recession and other economic factors.
The Covid-19 pandemic is said to be the greatest global shift since World War 2, and it doesn’t look like we’re even at its peak yet. Only time will show us the true economic effect of this once-in-a-century pandemic. Another harsh truth is that as one sector of a market suffers another usually flourishes.
Six months before lockdown office property was already bleeding. Estimates put the amount of vacant office space in Sandton at more than 1-million square metres. Add in a global pandemic and an unprecedented national lockdown, and the prospects for office property look even worse.
Under a strict lockdown and fear of infection with a disease that strikes in the most innocuous-seeming places, it’s understandable that nobody wants to be in an office right now. In fact, communal spaces could be an indulgence for a long time to come. Property owners are going to be forced to repurpose their property assets. They simply can’t sit with indefinite vacancies. The move from office to residential seems like the natural one.
Retail has been lingering for some time. Big malls have not been delivering fantastic returns but have always been considered solid properties. SA has far too many malls; US investors actually come to SA to learn how it’s done. As a country we build more square meterage of malls per head than even the US, the inventor of mall culture.
As a country we have overinvested in big malls and without good returns. People are going to stay away from congregating in large open areas. We’re going to have to watch big malls very closely. People don’t realise that a lot of our pension funds are invested in these malls, so a large chunk of company wealth is stuck here, and it doesn’t help that big retailers are abstaining from rent payments.
This has a knock-on effect beyond their own staff. It means that even the smaller businesses will take their lead and withhold their rent payments as well.
But where one opportunity falls, another rises. Convenience retail is the new golden opportunity. This is your smaller local shopping centres with community retailers like grocery stores, hair salons, pharmacies, takeaway shops and other smaller shops supplying basic things like airtime and cosmetics. These are the places where people can go in and out with less human interaction and crowding. This is where we will find growth in the foreseeable future.
Prior to the lockdown, industrial property was already performing better than retail and office, with real growth. In a post Covid-19 market, industrial should remain resilient because it is linked to essential services and supply chains. Coming out of lockdown in a phased approach, manufacturing and industrial businesses will be the first to reignite the fires to kick-start our economy.
This is a property market that we should all be keen to fund given that it poses the most immediate returns. The R500bn Covid-19 package announced by the government should filter into the industrial property space more than office and retail, with sectors such as mining, manufacturing, construction and associated supply chains likely to receive assistance first.
The full reopening of e-commerce also counts in the industrial sector’s favour, providing more certainty for landlords of warehouses and manufacturing facilities, especially if some of the trade that has been lost in the retail space can move online. Innovation in e-commerce could have a potential positive effect on the industrial sector.
As investors it is incumbent upon us to find the silver lining, and that silver lining is growth. Perhaps this pandemic was a levelling of the playing field that the property market needed to become more accessible. I am saddened by the suffering this pandemic will cause, but it’s important to consider what the world will look like after we come through this. Interest rates have already gone down, so it will be easier to raise the money. All that’s missing is the entrepreneurial spirit.
The problem is, it has become apparent that there are very few big players in the market. I wouldn’t call the commercial property market broad-based, and that needs to change. Most new entrants to the market simply cannot guarantee the repayments big players can, especially when tenants leave or withhold rent.
Based on my experience and recent research from some of the best minds in the sector, I expect that the next three years will be critical to our recovery, and that we should expect an upwards tick after that. In fact, I believe the silver lining is that we could be in for a market correction in favour of new entrants.
• De Sousa is Fedgroup Commercial Property finance executive.
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