Listed property, particularly commercial real estate investment trusts (REITS), has not been the same since the start of the pandemic. While some workers have been called back to the office, many organisations are committed to hybrid and remote work as a permanent part of their business models … meaning that demand for commercial property will be lower for the foreseeable future.
Following a dismal year for commercial property in 2022 with REITS on the FTSE, S&P and JSE all showing steep declines to their October lows, there are few signs that the sector’s prospects will improve based on sound fundamentals. Indeed, Kyle Bass of Hayman Capital Management goes as far as to say that it’s time to consider demolishing empty office buildings in US cities.
He argues that older, low-quality buildings with poor amenities will struggle to attract tenants in a market where vacancy rates are climbing amid mass lay-offs of employees in the BigTech sector. These buildings are not suitable to be repurposed as residential complexes that answer to the demand for housing in most US cities. Hence, it’s time to bring in the wrecking balls and tear down those vacant buildings.
This affirms our conviction that the investment case for REITS and commercial property is not built on solid foundations. Listed property has tended to rise and fall along with the equities markets, so it doesn’t offer much non-correlation as an alternative asset class. And with interest rates rising, the prevailing dividend yields are not that compelling relative to cash or bonds on a risk-adjusted basis.
There are also other headwinds on the horizon, with almost $1.5 trillion in US commercial real estate debt due for repayment before the end of 2025. Traditional banks and the bond market are backing away, potentially forcing borrowers to start settling debts. This all unfolds at a time when REITS lack the pricing power to pass inflationary increases on to their commercial tenants.
When it comes to the JSE, the SA Listed Property Index (Sapy), has delivered a total negative return of 1.18% year-to-date, underperforming both bonds and equities. Over five years, the Sapy has returned a negative 21,24%. While workers are returning to offices due to load shedding, the outlook for South African REITS is not positive, either. There is an oversupply of office and retail property nationwide. In addition, the operational costs of commercial properties in SA are rising due to the significant investment property owners are being forced to make to address the load shedding crisis. At the same time, weak business and consumer sentiment, along with poor economic growth, means that demand for office and retail space is not growing. It therefore seems unlikely that the SA commercial real estate sector will be able to hike rentals enough to compensate for higher financing and operational costs.
Dynasty currently has virtually zero exposure to commercial property in our flagship domestic and offshore portfolios. Our preferred engine for long-term growth remains quality equities with stronger pricing power, free cash flow generation and superior returns on equity, At the same time, our favoured instruments for yield are short-duration bonds and short-dated investment grade corporate credit. These instruments should also provide a large measure of protection in the event of further market drawdowns this year.
Please note that there will be no Newsflash next week due to the long weekend. The Newsflash will resume on Friday 5 May.
“The office is going the way of the farm and factory when it comes to Americans’ attitudes about work.”
– James Bianco, president of Bianco Research
Global News
- Buildings with empty offices in Silicon Valley have increased, while they have skyrocketed to brutal levels in San Francisco because of a wobbly economy and the sector being jolted by wide-ranging job cuts in tech and biotech businesses. Silicon Valley’s office vacancy rate rose to 23.1% in the first quarter of 2023, a new historical high, and was up from 22.7% in the final three months of 2022, according to a new report by Savills, a commercial real estate firm. San Francisco’s office vacancy level rocketed to 32.7%, “a new all-time high,” in the 2023 first quarter, up from 32.1% in the fourth quarter of 2022, Savills reported.
- The US economy has recently slowed down as hiring and inflation decline, and access to credit narrows. This is according to the Fed’s Beige Book survey of regional business contacts. Inflation slowed to 5% last month and is expected to continue to decline. Such data may add to concerns that the economy is slipping into recession and likely reinforces the chances that Fed policymakers will pause their run of interest-rate hikes following an expected 25bps increase at the next gathering in May.
- US Speaker Kevin McCarthy wants to raise the US debt limit by $1.5 trillion, which would stave off a default for about a year and cut federal spending, ahead of a planned House vote on the Republican proposal next week. If passed, the proposal will see President Joe Biden engage in talks to resolve the ongoing stalemate over raising the $31.4 trillion debt limit. If the proposal is not passed, the US would default on payment obligations as soon as June, which could cause economic and financial collapse.
- For the first time, more than half of those born between 1981 and 1996 (millennials) own a home in the US. The other half don’t have the means to buy a house, with almost 25% planning to rent forever, up from one in seven just three years earlier, according to a survey from real estate site Apartment List. However, US foreclosure filings gained 22% in the first quarter of the year compared to the same period a year ago, based on a report from real estate data analytics firm ATTOM. Foreclosure activity has increased on an annual basis for 23 straight months, reflecting a higher jobless rate, as well as ongoing economic challenges and backlogged foreclosures.
- With more Americans struggling to pay their bills, the $1.7 billion industry for repossessing such assets as cars, trucks and boats is gearing up for a boom. This will affect consumers and filter through to Wall Street, where car loans are packaged into bonds and sold to investors. During Covid years, relief measures for consumers meant repossessions largely dried up, leaving many repossession agents out of a job. Now, repossession companies are struggling to find enough workers to meet repossession requests.
- In the eurozone, there was a sharp drop in its consumer price inflation from 8.5% in February to 6.9% in March. Japanese inflation is below 4%. The UK is an outlier, with its inflation rate remaining stubbornly in the double digits, during March. This is a worryingly high reading that will increase the case for more interest rate rises by the Bank of England. Money market traders now expect two consecutive 25bps increases in May and June.
- Rents in London are rocketing at their fastest pace in more than a decade as private tenants fight over a dwindling supply of homes. Private property saw a 4.8% jump in prices last month compared to a year ago with further increases across the UK expected over the next year. There are 10 prospective tenants for every available property, according to Propertymark, a trade body for estate agents. Supply is under strain by a lack of housing and with landlords leaving the sector as bonds increase in price. There has been a huge increase in demand for rental properties, particularly from younger generations struggling to get onto the property ladder.
- China’s economy has gained at the fastest pace in a year in the first quarter thanks to the end of its Zero Covid policy, which has given way to stronger consumer spending and factory output. GDP expanded 4.5% in the January-to-March period from a year prior, according to data released by the National Bureau of Statistics on Tuesday. This was faster than the 2.9% pace in the previous quarter and higher than economists’ forecasts of 4%. China’s trade surplus in March was $88.2 billion, more than double market expectations, as the country recorded its first increase in exports since September 2022.
- India has overtaken China as the world’s most populous nation, according to United Nations data released on Wednesday. India’s population surpassed 1.4286 billion, slightly higher than China’s 1.4257 billion people, according to mid-2023 estimates by the UN’s World Population dashboard. China’s numbers do not however include Hong Kong and Macau, Special Administrative Regions of China, and Taiwan, the data showed. India, where half the population is under the age of 30, is set to be the world’s fastest-growing major economy in the coming years and is home to nearly a fifth of humanity — greater than the entire population of Europe or Africa.
- New York is again at the top of the list of the world’s wealthiest cities, with about 340,000 millionaires last year, based on research by investment migration firm Henley & Partners. New York is followed by Tokyo, California’s Bay Area, London, and Singapore. The annual survey looked at 97 cities in nine regions around the world. The Big Apple held its top spot after the number of high-net-worth individuals surged 40% in the 2012-2022 period. That was the same as Singapore, but lagged cities such as Shanghai, Houston, Dubai, and Mumbai. China followed the US with five cities in the top 50, putting it just ahead of Australia, which had four.
- Tesla will continue to cut prices to increase demand for its electric vehicles, which will come at the expense of its industry-leading profit margins. Billionaire Elon Musk has said Tesla can financially withstand price cuts, giving it the upper hand against rivals. However, investors were not convinced as the stock dropped in after-market trading. The price drops of Tesla vehicles has been dramatic. The base price of the Model 3 has now dipped below $40,000 in the US for the first time in years, a roughly $7,000 cut from the start of the year. Tesla’s net income and earnings dropped more than 20% from a year earlier in its first quarter results, close to analysts’ expectations.
- IBM has beaten the Zacks Consensus Estimate of $1.27 per share as it published quarterly earnings of $1.36 per share. This compares to earnings of $1.40 per share a year ago. The results represent an earnings surprise of 7.09%. A quarter ago, it was expected that this technology and consulting company would post earnings of $3.61 per share when it produced earnings of $3.60, delivering a surprise of -0.28%. Over the last four quarters, the company has surpassed consensus earnings per share estimates three times.
- French personal care company L’Oréal’s sales climbed 13% like-for-like in the first quarter of 2023, marking another quarter of market outperformance for this remarkable organisation. It reported sales of €10.38 billion in the three months to 31 March 2023, with “outstanding” performances in its Consumer Products and Dermatological Beauty Divisions. Consumer products sales were up 14.7% due to the company’s ongoing “premiumisation strategy” and “significant volume growth”. Make-up was the fastest growing category for this period, driven by hotly anticipated launches.
- Apple has joined the competition for bank deposits, launching a high-yield savings account that pays an annual percentage yield of 4.15%. It’s available in conjunction with Apple’s credit card and is Apple’s latest steps into the financial services space, which also includes an option to allow customers to “buy now, pay later” on certain of its hardware products. Apple opened its first retail outlet in India, in Mumbai, on Tuesday. The company sees India as important, as it only has a market share of 3% in that country.
- As at Thursday’s close the S&P was down 0,17% for the week.
Local News
- South Africa’s office vacancy level improved in the first quarter of 2023 after peaking at a new all-time high of 16.7% during the second quarter of last year. According to the South African Property Owners Association Office Vacancy Survey, the overall vacancy rate at quarter-end March was 15.8%. The most recent survey’s sample comprised 3,108 office properties across 52 nodes and 19.1 million square meters of gross lettable area including developments currently under construction.
- The Reserve Bank is sticking to its 2023 inflation forecasts even as it expects the price of living to drop back to between 3% and 6% later this year. Although inflation cooled month-on-month to 7.0% in March when compared with 7.1% in February, it remains stubbornly elevated. Inflation was pushed higher as food became more expensive. The cost of staples and worries about food security have almost reached crisis levels. Consistent rolling blackouts and higher power prices, which affects every sector of society, also pushed the cost of living up. Prices of food and non-alcoholic beverages rose by 14.0% over the past year, the biggest increase in 14 years. This contributed 2.4 percentage points to the total CPI annual rate of 7.1%.
- Reserve Bank governor Lesetja Kganyago has urged politicians to make hard, unpopular fiscal choices to maintain the credibility of budgetary commitments as they juggle spending pressures with one of the heaviest debt loads in emerging markets. With South Africa trapped in the longest downward phase of the business cycle since 1945, he said government cannot promise South Africans what it cannot deliver.
- Business confidence slipped in March by 0.6 index points to 111.3 versus 111.9 recorded in February. The reading is consistent with other economic indicators pointing to the crippling effect of electricity rationing on businesses. However, tourists coming into the country aided the measure, thanks to the weak rand, while exports also increased.
- Ahead of next year’s general elections, veteran journalist Stephan Grootes, says president Cyril Ramaphosa will soon have to demonstrate willingness and strength to lead South Africa. The president, says Grootes, has been rendered politically impotent. The fact that he sought office means that he has a moral obligation to lead, one way or another. Old Mutual chair and former finance minister Trevor Manuel has been scathing in his assessment of the country’s political leadership, saying the time has come for government to get its house sorted out to resolve the myriad challenges facing the country.
- Ramaphosa, who has attended every G7 summit since becoming president, has not been invited to the next meeting in Japan in May. This could have something to do with the fact that South Africa declined to attend Japan’s own big Ticad summit with African leaders in Tunisia last year, but could also be related to South Africa’s failure to condemn Russia’s invasion of Ukraine, which has increasingly irked Western and like-minded countries.
- As minister of Electricity Kgosientsho Ramokgopa wants to provide additional funding to Eskom to fix its plants, this could jeopardise South Africa’s ability to secure financing for its just energy transition programme and further delay the publication of the revised Integrated Resource Plan. This comes as Ramaphosa has affirmed South Africa’s push to renewables in order to meet its net zero target by 2050.
- An interim board has been appointed to state owned airline SAA ahead of a possible sale to Takatso Consortium. The new SAA board will be led by Derek Hanekom, a former tourism minister who is likely to have a firm grasp of the economic importance of facilitating the influx of tourists into South Africa. President Ramaphosa has also appointed a 12-member SABC board that will be headed by former National Youth Development Agency CEO Khathutshelo Ramukumba.
- Cape Town-based asset manager Coronation Fund Managers has warned that it will not report a dividend when it releases half-year results in May, as profit is expected to plummet. This due to the court costs related to a dispute with the South African Revenue Services. It said in a trading update on Friday that fund management earnings per share are expected to fall between 110%-120% in the six months to end-March, which will result in a loss of between 21.5 to 43c per share. The dispute with the taxman relates to its reporting of earnings from its Irish subsidiary and whether it should have been included in Coronation’s earnings as taxable income.
- Capitec, South Africa’s largest bank by customers, may have more than 20 million clients, but credit impairments have soared 80% to R6.3 billion. This, its CEO, Gerrie Fourie, says is mostly due to the deteriorating economy and the impact of higher inflation on clients while he urged South Africans to live within their means. Net loans and advances grew by 17% to R78.2 billion, while total deposits and wholesale funding stood at R146.5 billion for the year. Over the past year, Capitec decreased lines of credit for those who were battling which, in some cases, dropped to zero. Its approval rate on loans, at 45%, is at the lowest ever even as credit applications flood in, up to 4 million from 2.8 million a year ago.
- Clicks has reaffirmed its plans to invest R958 million into increasing its store and pharmacy footprint, refurbishments and improving supply chain efficiencies, despite consumer disposable income coming under pressure. The investment will include R477 million in spending in “new stores and pharmacies and the refurbishment of 45 stores” and a R481 million investment in “supply chain, technology and infrastructure, including battery storage at its main distribution centre” the group said.
- As at the time of writing, the rand was flat for the week while the ALSI was 1.1% lower.
Sources: Dynasty, Reuters, Daily Maverick, Bloomberg, Daily Investor, BusinessLIVE, News24, EWN, New York Times, Wall Street Journal, FM, CNBC etc.
