Doughnut effect hits office nodes

Property professionals predict interest rate hikes soon in the commercial sector, as CPI and inflation rise, mirroring global trends

Q: What is the doughnut effect in terms of commercial property?

A: Big office nodes currently have some interesting risks, a major one being what is referred to in the US as the “doughnut effect”. That hollow part of the doughnut symbolises the CBD (or decentralised office nodes, in our case) that underperforms the more outlying suburban areas because there is no rush to be in these nodes any more from a residential point of view.

So, would people want to live in the high-density areas of the Cape Town CBD or Sandton or Sunninghill? I do not think so. So, I think there will be a lack of demand for residential and office space and that means more significant value drops there than in many of the outlying areas. – John Loos, FNB commercial property economist

Q: As an aspiring commercial property investor, I am trying to ascertain the current state of the rental market in terms of tenant payment performance. Is there any improvement?

A: Commercial tenant payment performance is typically a mirror of the economy and strongly influenced by economic growth as measured by GDP. Tenant payment performance levels tend to be higher when there is economic growth and lower when the economy is struggling.

This tendency was particularly evident in 2020. Although commercial tenant payment performance continued its recovery trend in the fourth quarter of 2020, it is a long way off from being fully recovered.

In the second quarter of 2020 – at the height of the lockdown – only 50.36% of commercial tenants were in good standing with their landlords, according to TPN’s Quarter 4 Commercial Rental Monitor. This figure recovered to 56.19% in the third quarter and to 61.2% in the last quarter of 2020, indicating a gradual recovery in tenant payment performance as lockdown restrictions were eased.

Tenants in good standing are those who have settled their balance in full, including for additional charges such as parking, utilities, municipal costs and arrears.

However, although commercial tenant rental payment performance has shown signs of recovery, of concern is the fact that the rate of recovery is slowing down and continues to remain well below pre-Covid-19 levels of 77.85%, which were recorded in the first quarter of 2020, and significantly below the high of 83.56% achieved in 2012. – Michelle Dickens, chief executive officer, TPN Credit Bureau

Q: If I decide to invest in commercial property, which sectors are faring the strongest in terms of rental payments?

A: Retail made the best recovery of all the commercial property sectors by the fourth quarter, recovering from a low of 45% in good standing in the second quarter to 61% in good standing by the end of the year with lower vacancies cushioning the higher delinquencies.

The industrial property sub-sector saw tenant rental payment performance improving from 54% in the second quarter to 65% by the fourth quarter, according to Commercial Rental Monitor. This sub-sector is heavily impacted by the manufacturing sector. Indications are that a further recovery in this area will be hard to achieve given that the Manufacturing Purchase Managers Index New Sales Orders for the first quarter of 2021 shows only a mediocre performance.

Exacerbating the challenges facing this sub-sector are power-supply disruptions. Although power disruptions impact all tenant sectors, they impact industrial tenants the most.

Our data indicates that the office subsector was the best performing category in 2020 with 61% in good standing in the second quarter, recovering to 71% by the fourth quarter. However, this is the sub-sector likely to face the most significant challenges going forward, given the higher vacancies as many businesses opt to keep their employees working from home.

Outperforming all three major commercial property sectors was the storage sub-sector which recorded only a moderate dip of 78% of tenants in good standing in the second quarter of 2020. However, by October this figure had recovered to 90%. – Michelle Dickens, chief executive officer, TPN Credit Bureau

Q: What does the recent Reserve Bank announcement that the repo rate will remain at 3.5% mean for commercial property?

A: Interest rates have been held flat, given the data coming through, but it’s quite clear that the Consumer Price Index and inflation figures are trending upwards – mirroring a global trend. It is highly probable that we will be seeing interest rate hikes in the near future, with expectations that the inflation rate will rise to 5.1% this month.

This window of opportunity that investors have had to buy property on the basis of low interest rates (enabling them to pay more attractive yields to sellers) and perform big transactions on properties with long-term leases is coming to a close and sellers should capitalise on the status quo.

The projected growth rate of 4.2%, which is the highest it has been in over a decade, is a sign of market strength that has been sorely missed and that will be welcomed by the commercial property sector.

The last time we saw such high growth projections, in 2007, we saw huge asset price inflation and a spike in property prices and rents.

However, the challenge in this cycle is that, because of Covid-19, there is a huge glut in commercial office space vacancies. Vacancy in this sector would have to be taken up before we could see any actual growth and, given the rise of remote working, the demand for office space has significantly dropped.

On a more optimistic note, industrial real estate still has relatively low vacancies, so we hope to see net growth and development in that sector. – John Jack, chief executive of Galetti Corporate Real Estate

The ‘doughnut effect’ means that South Africans no longer have the need to live in high-density areas. PICTURE: ALEKSEJS BERGMANIS/PEXELS