State-proofing SA's commercial real estate industry

"There is no doubt that the property industry is in the midst of a structural change". This was one of the opening comments made by Nedbank Chief Economist, Nicky Weimer, at SAPOA's 2022 Convention and Property Networking which took place between the 28^th and 30^th of September 2022, sponsored by Attacq Limited, Dipula Income Fund, Fortress REIT, Growthpoint Properties, Liberty Two Degrees, Pareto Limited, Remote Metering Solutions and Resilient REIT.

After a three-year hiatus, over 800 property professionals from SA's commercial property industry joined forces at Sun City Resort to discuss and debate critical issues including the volatile economy, rising municipal costs, the remnants of the July 2021 civil unrest and failing infrastructure.

A mixed story for SA's real estate sector

The pandemic has written a tale of two worlds for the real estate industry; while residential property has fared exceptionally well, it has been a very different story for commercial property which continues to endure significant strain.

In the face of decreasing investor confidence, a water and electricity crisis and high tenant vacancies, commercial property owners have grappled with restoring balance sheet strength, rebasing income levels and repurposing income growth potential.

"It is very likely that SA will continue to deliver below its potential growth on its current path," commented Ahmed Motara, Listed Property Analyst for STANLIB Property Income Fund during a panel discussion. "The property sector is positioning itself to deliver traditional returns of low double-digits, and even higher short-term capital returns when bonds and rates marginalize. Long-term future and current returns will likely be more skewed to income yield than capital growth".

"A stock is a function of an underlying portfolio, with most portfolios now in a defensive shape. While the challenges and risks are well understood, five years of challenges can - and have - led to - resilience".

Property rates costs have increased by more than inflation across SA

Property rates (levied as a rate in Rand by municipalities) have increased sharply in recent years, rising by more than 50% since 2010 and when viewed from an international perspective, SA ranks much higher than the global average in terms of property taxes when expressed as a percentage of GDP.

During a panel discussion, 'The Damaging Effects of SA's Unsustainable Property Rates Regime', Cobus Hart from Oxford Economics discussed the preliminary findings of a report on the socio-economic impact of rates and taxes being imposed by municipalities:

"Water and property rates inflation was on average 3.2 percentage points higher per annum than headline urban inflation over the past ten years. Headline Consumer Price Inflation (CPI) has increased by about 71.6% between 2020 and 2021 while water and property costs have risen almost twice as fast with an increase of 139.5%," he said. 

Municipalities increasingly rely on grants and subsidies which still represent the bulk aggregate of municipal income across SA but the share of grants and subsidies to total revenue has declined sharply in recent years. This shortfall has been made up through larger income shares for water sales and taxes from property rates.

"Over the previous decade, aggregate municipal revenue rose by 138% but income from grants and subsidies increased much slower by roughly 106%. In contrast, income from property rates has increased by a substantial 167%, only exceeded by revenue from the sale of water," he said.

"Overall expenditure by municipalities rose by 149% during the previous decade, higher than the rise in national government spending at 123%. Our preliminary findings suggest that property tax income is used to support increased spending on the likes of employee costs and contracted services."

From a provincial perspective, water and property rate costs have increased the most in the Eastern Cape, Gauteng, and KwaZulu-Natal with increases comparatively lower in Limpopo and the Western Cape.  

When sampling a few of the larger metro municipalities including Nelson Mandela Bay, Johannesburg, Cape Town, and eThekwini, the report highlights that these municipalities have become more reliant on income from property rates. Most recently, all of the municipalities sampled have property tax income shares significantly in excess of the national municipal average of 17%.

"Property rates are based on an unfair and unacceptable system. Over the last decade, rates and taxes have consistently increased at a faster rate than inflation and has increasingly come under the microscope as landlords focus on preserving their income in a tragic trading environment," commented then President of SAPOA and CEO of Redefine Properties, Andrew Konig, during his opening address.

"Rising operating costs threaten the sustainability of net returns across the spectrum of commercial real estate and industrial property investments. As property owners, we are invested in a long-term asset class ... To demand a bigger slice of the shrinking cake is what property rates increases amount to. If municipalities want to attract further investment, they should set an example by tackling corruption and addressing their costs base."

State-proofing: what if the civil unrest occurs again?

An occurrence like the July 2021 riots has never been experienced. As the volatility escalated, commercial property owners quickly realised that government would not be coming to their rescue, and it boiled down to protecting their assets within their limitations.

"The moment the communities realized that SAPS was not coming, the real looting began", remarked Mpumi Tyikwe, Group CEO of SASRIA. "This cost SASRIA and the economy. If the government had responded in the way in which the industry anticipated it to, the claims would have been significantly less than the R33 billion we are currently dealing with".

While the sparks that set off the civil unrest were thought to be political, a threshold was crossed and Piet le Roux from non-profit Sakeliga believes that we cannot leave the pandemic, its subsequent unemployment, and the trend of years of poor service delivery out of the equation:

"The extent of the damage incurred boils down to institutional decay. When this happens, there is something in place for a section of the population to cross the threshold of being disorderly. Importantly, last year there was an accentuation of unemployment with up to 2 million South Africans having lost their jobs. In a dire situation, these circumstances came together with a government that was unable to maintain order in a situation accentuated by years of bad policy and the ultimate deterioration of the economy."

Lessons were learnt from the events of last year and it is evident that a mindset change has taken place. Commercial property owners are now factoring in non-existent support from government in their scenario planning, should another tragic event like this were to occur.

"We need a new approach for the future. I believe a big part of what occurred last year started with the intelligence. We need to be proactive, and we need to get our communities and the private sector more involved in protecting our assets", commented Wahl Bartmann, CEO of Fidelity Group.

The big question: can the industry afford another round of civil unrest?

"The occurrence last year was harmful and at a cost, but order was restored by a culmination of the private sector and communities," said Piet. "What we are seeing is a mind shift in doing a thought experiment; what if the State is incapable, what do we need to put in place as a business and as a community? Can we 'state-proof' ourselves?"

A sector in need of recovery

"We find ourselves in a period that is characterised by the volatile and unpredictable business environment, where most industries, including the property sector, experienced margin contraction and diminishing incomes," said Malose Kekana, Group CEO of Pareto Limited, SAPOA's new President, during his official address.

"Now, more than ever, collaboration and partnership with communities within which we operate, becomes important. This is the only way that the sustainability of the property sector can be guaranteed. Shared community values should be central to the new way of doing business".