The world economy is experiencing an exceptionally strong but highly uneven recovery. Global growth is set to reach 5.6% in 2021, according to the World Bank, underpinned by steady but highly unequal roll-out of the vaccine. Growth is concentrated in a few major economies, with most emerging market and developing economies lagging. While about 90 percent of advanced economies are expected to regain their pre-pandemic per capita income levels by 2022, only about one-third of emerging markets are expected to do so.

The US economy is growing again after large parts of the country had been shut down for much of 2020. Real GDP rose at a 6.4% annual rate in the first quarter. The World Bank recently raised its 2021 GDP growth forecast for South Africa to 4% from 3.5% earlier in the year as the country benefits from a recovery in global output, especially in China and the US, two of its main trading partners, and favourable commodity prices. The recovery in commercial real estate, like much of the rest of the economy, is likely to be uneven across sectors and subject to various lags and delays.

Region 2019 2020 2021f 2022f 2023f
World 2.50% -3.50% 5.60% 4.30% 3.10%
Advanced economies 1.60% -4.70% 5.40% 4.00% 2.20%
Euro area 1.30% -6.60% 4.20% 4.40% 2.40%
South Africa 0.20% -7.00% 3.50% 2.10% 1.50%
Central Europe* 4.70% -2.70% 3.80% 4.50% 3.90%

CUMULATIVE IMPACT: 2019 = 100

Region 2019 2023f Annualised growth
World 100 110 2.31%
Advanced economies 100 107 1.65%
Euro area 100 104 1.00%
South Africa 100 100 -0.06%
Central Europe* 100 110 2.33%

Source: World Bank April 2021

Source: SAPOA retail trends report Q1 2021, Catalyst Fund Managers

Signs of recovery in the SA retail sector have started to emerge with the monthly trading density growth for the month of March 2021 at 4.4% (the highest since February 2020 as lockdown regulations loosened). However, the current third wave of infections and lockdown restrictions imposed are likely to slow down this recovery trend, together with the ongoing unrest in some parts of the country. During the previous waves there was a noticeable slowdown in retail sales as a result of tighter regulations.

Retailer’s cost of occupancy (gross rental to sales) has increased by 150bps since February 2020 to 9.5%. The increase is attributable to the plunge in retail sales impacted by lockdown restrictions. Retail landlords granted significant rental concessions and deferrals over the lockdown period; however, this relief was temporary, and a normalisation of retailers cost of occupancy would depend on a rebound in trading conditions.

Source: SAPOA retail trends report Q1 2021, Catalyst Fund Managers

Despite significant rental relief provided to assist tenants, we still witnessed an increase in vacancies across all shopping centre types. During the lockdown period, smaller format retail outlets outperformed as consumers avoided the large malls and directed their spending power to their local neighbourhood and community centres. The vacancy rate of the malls forming part of the MSCI South Africa Retail Trading Density Index was recorded at 6.5% at March 2021, up from 3.8% at December 2019. Over the past 6 months, neighbourhood shopping centres were the only category to see an improvement in occupancy rates with vacancies reducing to 7.3% from 8.2% reported in September 2020.

Source: SAPOA office vacancy report, Catalyst Fund Managers, 30 June 2021

The deterioration in office vacancies has been felt across the different grades and indicates a softening of the market rather than pressure on a specific node or office grade. A-grade office segment saw the largest deterioration during the quarter as its vacancy rate increased by 90bps to 13.2%. Given the high vacancy rates, asking rental growth was negative at -1.4%, but anecdotal evidence suggests that some deals are being done at substantial discounts to asking rentals.

Many companies had chosen January 2021 as an initial date to start the re-occupation of the office market; however, the 2nd and 3rd wave of infections further delayed that decision and a likely return to a ‘normal’ office environment should not be expected in the short term.  Shadow vacancy where landlords are collecting rental even though the space is not being optimally utilised, poses a risk to further increase in vacancies once the leases come up for renewal. In this regard, uncertainty remains on what will constitute a ‘normal’ office environment in the future and what would be the space requirements and its configuration in this new environment.

Source: SAPOA office vacancy report, Catalyst Fund Managers, 30 June 2021

Office development activity remained constrained in Q2 2021 after recording an all-time low in Q1 2021. Given the uncertainty surrounding the Covid-19 pandemic and high vacancies in the sector, office development activity is likely to remain muted and mainly tenant driven. Development under construction currently stands at 53k sqm leaving development activity at 0.3% of existing market stock and has continued to trend downward since 2015.

The industrial subsector continues to benefit from structural changes due to the acceleration in e-commerce sales and the drive to improve supply chain efficiency. SA’s e-commerce market is still in its infancy, with online sales estimated to have increased from between 1% and 2% in 2019 to between 2% and 4% in 2020.

Nominal rentals in the second quarter of 2021 grew by 0.8% year-on -year amid continued low vacancies, according to Rode’s industrial survey data, but still well below the 5% rental growth achieved in 2019. The slow rental growth shows that the industrial sector continues to be impacted by the subdued macroeconomic environment, albeit not so much as the office and retail property markets. National vacancies in the distribution center subsector remains low relative to the industrial and other subsectors.

Source: MSCI, Equites results presentation February 2021

Source: StatsSA, Catalyst Fund Managers, 2021: Year-to-date data as at 30 April 2021

The increased investment into e-commerce capabilities and the need to optimise supply chains has led to an increase in logistic space demand, both locally and internationally. In this regard, we have seen a noticeable supply response over the last few years with the amount of industrial space being built exceeding the long-term average. For 2021 year-to-date, we note a reduction in completed space largely due to delays caused by lockdown restrictions in the 2020 calendar year. Given the uptick in building plans passed, we expect a sharp increase in completed space in the coming months given the increase in demand from retailers who continue to adapt to changing consumer demands. Despite the structural demand drivers in this sector, we believe rental growth is likely to remain subdued. This is due to a weak economic backdrop, availability of land for new construction and the lack of building cost inflation over the last few years which is placing a ceiling on market rental levels.

Source: StatsSA, Catalyst Fund Managers, 2021 YTD:  Data as at 30 April 2021

Source: Bloomberg, Catalyst Fund Managers June 2021

The severe economic fallout combined with a subdued inflation outlook led to an unprecedented 300bps cut in the repo rate to 3.5%. This is the lowest it has been since 1998. The swap curve widened by 127 bps since the start of the year, with the 5-year rate now at 6.0%. While the swap curve has widened in the short term, the majority of the debt in the listed property sector is subject to fixed rates (75%+), and earnings should not be materially impacted by this in the short term.

Source: Bloomberg, Catalyst Fund Managers, 30 June 2021

During 2020, we saw the debt to asset ratios across the sector increase as direct property valuations came under pressure. The current debt to total assets ratio of c. 37% is below the 40% reported end of December 2020 and is starting to trend lower towards the historical average of 32%. Encouragingly, most listed REITs loan-to-values remain below average bank covenant levels of 50%. The reduction in loan-to-values in the period can be attributed to the retention of dividends due to lowered pay-out ratios, equity issuances and completed property disposals by some companies.