The property market has continued to weather different storms. These are the expectations for the property market in 2022.
The longer-run property market correction is expected to normalise in 2022, said FNB Commercial Property Finance Economist, John Loos, at FNB’s November quarterly property market briefing.
“By ‘normalise’, I mean that the all-out decline in average capital values across the commercial property sector will end."
We will revert to very low growth in capital values, which won’t be sufficient to keep up with general inflation in the economy.
"This will translate into ongoing correction in capital values in real terms, as property markets often slowly correct over long periods.”
Loos believes that after the significant 9.5% decline in average commercial property values from the latter half of 2018 to the first 6 months of 2021 - according to MSCI half-yearly data recently released - there will probably be a move back into a low positive growth in the All-Property Average Capital Value in 2022. He pointed to the first half of 2021 data seeing a second consecutive semester of a decreasing rate of average property value decline after significant declines in 2020.
Loos said that 2016 was the year in which the correction started, in what he sees as a delayed response to broadly stagnating economic growth since around 2012.
“While actual (nominal) valuations weren’t yet declining significantly until much later, nine out of 11 semesters from 2016 onwards have shown real - GDP inflation-adjusted, which is the proper way to assess a correction - declines in average values when compared with the preceding semesters.
“So, while actual valuations have decreased by far less, in real terms, the cumulative decline in the MSCI All-Property Average Capital Value has been a significant -29% from the first half of 2016 to the first half of 2021,” said Loos.
Loos believes that while actual values will stop their decline in 2022, the ongoing gradual correction will continue throughout the FNB three-year forecast horizon in real terms.
“This is due to the expected path of the economy”, he said. “After a severe real Gross Domestic Product (GDP) contraction of -6.4% in 2020, a subsequent recovery in growth in 2021 and beyond improved demand for commercial property as a whole, just curbing oversupplies somewhat, which I expect to end value decline in 2022.”
However, the economic growth recovery he spoke of doesn’t appear sufficient to bring about real inflation-adjusted value growth. Moreover, this expectation is based on FNB’s GDP forecast, which, although it is recovering, is only expected to reach the same level as in 2019 in 2022. “In 2019, the All-Property vacancy rate trend continued to rise, so I don’t see the rising vacancy rate - almost in double digits recently - turning downward just yet. As a result, I would expect market rentals and real operating incomes on property to remain under pressure.
“I expect the correction to continue more gradually in 2022, with real value correction persisting but no longer all-out nominal decline. The gradual real value decline is less of a concern to mortgage lenders than an all-out decline in the actual value of the security behind the loan,” said Loos.
FNB forecasts real GDP growth to slow down to its pre-Covid-19 pedestrian rates following the 2021 post-lockdown surge. After an expected 4.7% growth in 2021 - the result of an extremely low lockdown base created in the deep recession of 2020 - growth is expected to taper once more to 2.2% in 2022 and then further slow to below 2% in the following years.
The reasons for the slow projected growth after the initial post-lockdown spike are South Africa’s well-documented structural constraints, severe capacity limits in the broader public sector and its parastatals, ageing infrastructure and ongoing capital expenditure weakness in that sector.
“The recent erratic electricity supply - and another severe hike in electricity tariffs which Eskom is expected to request - is just one obvious critical constraint on growth in the economy,” said Loos.
And now, as the South African Reserve Bank starts its interest rate hiking cycle, interest rates become a further mild dampener on demand in what is a highly credit-dependent market.
This long-term stagnant growth is the basis for ongoing valuations correction in real terms. Loos believes the SARB will go easy on the interest rate hiking, mindful of the fragile economy. FNB only expects another two 25 basis point interest rate hikes in 2022 following the recent first hike.
According to Loos, longer-term interest rates are expected to continue their multi-year upward drift. This upward drift is influenced by short term interest rate rises along with a high and further rising level of the Government’s debt-to-GDP ratio driving Government long bond yields higher.
Loos said the industrial property class is presently in the pound seats, whereas office and hotels remain in the doldrums.
He expects offices and hotels to remain the underperforming markets, and they could still experience further nominal value decline. In contrast, he believes the return in the All-Property Average Capital Value to low positive nominal growth will be driven by the industrial property class and to a lesser extent by retail – both of which are expected to see low positive nominal capital growth.
He said there is possibly over-optimism in the future of industrial property, given that economy-wide inventory levels remain very low, and manufacturing is still mediocre at best.
“But industrial property is the most affordable property class and arguably the most adaptable, while also benefiting from a gearing up of the logistics sector for greater levels of online retail. Relatively speaking; therefore, this class has quite a bit going for it, it would appear,” said Loos.
Hotel revenues and occupancy rates remain far below pre-Covid 19 levels, and Loos believes foreign tourists will filter back in 2022, but not yet at pre-lockdown levels. However, he also thinks a large part of daily business interaction has been permanently “Zoomified”, and a percentage of corporate business travel won’t return. The hotel property market is thus expected to lag the other three major commercial property classes in recovering.
This property class will be particularly hard hit by the recent travel bans on South Africa issued by many countries around the world, including the UK, the US, EU countries and Australia.
In the struggling office market, the national average vacancy rate is expected to continue climbing in 2022. Many companies are revising their office space needs as the remote work trend surges.
“As lockdowns ease and economic activity normalises, many corporates have gone back to their offices. But I believe the level of office working won’t go back to the same as before the lockdowns. Instead, as technology continues to improve, the multi-decade trend towards greater remote work levels will continue,” said Loos.
People often overlook two other pressures on demand for office space.
"The first is the normal recession effect, which caused a significant drop in employment numbers in the office-bound sectors of the economy. Even without any increase in remote work, there are fewer employees in these services sectors, so less office space is needed.
“In addition, the improved utilisation of desk space seems to have picked up lately, with “hotelling” of desk space being the buzz. Hotelling refers to a desk booking system, where employees book a desk for a day or don’t have one. Gone are the days’ therefore, when every employee had a desk reserved for themselves, meaning a large portion of desks standing empty much of the time. This sharing of desk space will further reduce the need for office space in future,” said Loos.
Finally, Loos expects the residential rental market to turn stronger in 2022.
“This market has been under severe pressure recently. This is partly because of the negative impact on tenant finances and payment performance from the 2020 recession, as well as the early-2020 interest rate cuts, which spurred many aspiring first-time buyers to become homeowners. This left a gap in the rental market,” said Loos.
“Now, the onset of rising interest rates is likely to do the opposite. As a result, a portion of aspirant buyers will put buying on hold and continue renting instead. In addition, tenant performance in the residential market has continued to improve since the 2020 hard lockdowns. Overall, prospects look a little brighter for the residential rental market in 2022.”