The world economy has still not fully recovered from the consequences of the Covid-19 pandemic and its recovery has been hampered by further global setbacks. The invasion of Ukraine has had global ramifications on commodity markets, supply chains, inflation and a material change in financial conditions. The world economy’s growth is expected to slow to 2.9% for 2022 according to the World Bank. This represents a 1.2% reduction in growth from their January forecast with most of the downgrade being accounted for by the effects of the war including inflationary pressures and faster pace of monetary tightening. Growth projections for 2022 have been downgraded for most economies with the outlook still subject to further downside risk which include further geopolitical tensions, stagflationary headwinds, financial instability, supply constraints and food insecurity.

Real GDP growth rates

Region 2019 2020 2021e 2022f 2023f 2024f
World 2.60% -3.30% 5.70% 2.90% 3.00% 3.00%
Advanced economies 1.70% -4.60% 5.10% 2.60% 2.20% 1.90%
Euro area 1.60% -6.40% 5.40% 2.50% 1.90% 1.90%
South Africa 0.10% -6.40% 4.90% 2.10% 1.50% 1.80%
Central Europe 4.50% -3.30% 6.20% 3.70% 3.70% 3.70%

Source: World Bank Global Economic Prospects June 2022. Central Europe includes Bulgaria, Croatia, Hungary, Poland and Romania. “e”: estimate; “f”: forecast

The recovery in the SA retail sector continued in 2022 with annualised trading density growing by 21.1% year-on-year in the first quarter. The trading density ended the quarter at an annualised R35.4k per sqm which was the first time it has exceeded its pre-pandemic comparable of R35.0k per sqm. The improvement in trade has resulted in retailer’s cost of occupancy (gross rental to sales) declining from the peak of 9.5% in the first quarter 2021 to 7.6%, which is below its pre-pandemic comparable.

Source: SAPOA retail trends report Q1 2022, Catalyst Fund Managers

 

Overall national vacancy rates have continued to improve with current vacancy rates at 5.6% compared to their peak of 7.0% in March 2021. Vacancies have improved across all retail segments with the lowest recorded in regional centres (4.5%) and highest in neighbourhood (8.2%)

Source: SAPOA retail trends report Q2 2021, Catalyst Fund Managers

National office vacancies deteriorated in the year and currently stand at 16.7%, above the pre-pandemic peak of 15% recorded in March 2003. While the vacancy rate remained largely flat quarter on quarter, it remains significantly higher than the long-term average of c. 10.6%. Office landlords continue to provide generous incentives and low asking rentals to retain and attract new tenants, resulting in negative reversions on expiring rents. Economic growth, certainty on work from home and increased business confidence will be required for a significant sustainable reduction in the vacancy rate over the short to medium term.

Source: SAPOA office vacancy report, Catalyst Fund Managers, 30 June 2022

The future supply situation has moderated with only 126k sqm of office space currently under development. As a percentage of existing stock, this equates to c. 0.7% which is below the long-term average. New supply is likely to remain muted over the short to medium term given the amount of space readily available. Current developments are 72% pre-let which indicates that developers are only likely to start new office developments with a large proportion pre-let.

Source: SAPOA office vacancy report, Catalyst Fund Managers, 30 June 2022

 

SA’s e-commerce market is still relatively small, with online sales estimated to have increased to 2.8% in 2020 (World Wide Worx); however, the structural changes catering for the growth in e-commerce and the improving supply chain efficiency has benefitted demand for modern well located industrial facilities. Nominal rentals in the second quarter 2022 increased by 5.4% year-on-year for space of 500sqm according to Rode’s industrial data. The growth compares favourably with the 2.2% and 0.5% recorded in 2021 and 2020 respectively.

The industrial sector has had mixed results depending on the type of industrial (with larger more modern facilities having better demand) and a function of when the original leases were negotiated. Construction inflation is currently being passed on to the tenant through higher rentals, as demand continues to outstrip supply. Industrial vacancies have been well contained on average with better performance coming from distribution centres and warehousing. Comparing the vacancy rate of the three major property sectors shows that industrial’s vacancy rate is the lowest among the major sectors (retail, office, industrial).

Source: StatsSA, Catalyst Fund Managers, 2022: Year-to-date data as at 30 April 2022

New industrial supply has been relatively buoyant over the last few years with 2022 year-to-date completions at c. 44% of the long-term average for a 3rd of the year (with the latest data point end of April 2022). Building cost inflation (BER BCI) spiked to c.13% in the second quarter driven by large increases in steel and copper. Sustained high inflation in building cost will put pressure on the viability of new industrial developments unless there is a commensurate increase in new asking rentals.

Source: StatsSA, Catalyst Fund Managers, 2022: Year-to-date data as at 30 April 2022

 

At the onset of the pandemic, the South African Reserve Bank (SARB) cut the repo rate by 300bps to 3.5%, which was the lowest since 1998. It was generally expected to be temporary and to provide relief during the Covid-19 pandemic. Since November 2021, the SARB has raised interest rates four times with a cumulative increase of 125bps. The swap curve widened by 218bps since last year, with the 5-year rate now at 8.18%. Inflationary pressures are a key concern locally and abroad with the expectation of tighter monetary policy reflected in the widening of the swap curve.

Source: Bloomberg, Catalyst Fund Managers 30 June 2022

 

The increases are not expected to materially impact on landlords in the short term given the fixed nature of debt maturities, but we do expect interest coverage ratios to come under pressure over time. On average the sector has circa 75%-80% of its debt fixed for an average tenure of 3 years.  We do, however, expect these increases, coupled with the above-mentioned inflationary pressures and the effects of the ongoing war to impact on consumer and business confidence leading to subdued GDP growth.

The debt to assets ratio for the sector peaked at c. 42% as property valuations declined due to weaker fundamentals and changes to risk parameters. The ratio continues to trend downwards and is currently 36%. While it remains above the long-term average of 32%, it is well within average bank covenant levels of 50%. The lower debt to assets ratio is due to retained dividends, lower pay-out ratios, disposals and equity issuances including dividend reinvestment plans.

Source: Bloomberg, Catalyst Fund Managers, 30 June 2022