The winds of change are blowing in Sandton, Africa’s “richest square mile” covering more than 130km2 of premium (P) grade high-rise office blocks and home to corporate headquarters including the Johannesburg Stock Exchange (JSE) – the continent’s largest bourse.
The Covid-19 crisis has dented the sector and fast-tracked SA Corporate Real Estate Limited’s (SAC) exit from real estate focussing on premium office spaces. Excess supply, which predates the pandemic, has strengthened the real estate investment trust’s (REIT) scepticism about the office market.
“While no one can forecast the future, the office as we know it today is going to evolve,” says Rory Mackey, CEO of SAC, a JSE-listed REIT.
“I don’t believe it’s going to be as dominant as it was in the past.”
The future of the office
Globally, a hybrid model is emerging as a frontrunner in office arrangements, with trend reports suggesting that even as much as a third of employees will continue working remotely or go into the office occasionally.
Domestically, South African REITs have extensive exposure in the Sandton area, “where we had a lot of developments of some P-grade offices,” Mackey says.
Premium developments in Sandton represent the breadth of the country’s corporate sector and accommodate customers from financial services, including the big banks, health and energy companies to major legal firms.
SAC’s engagements with its bank clients reveal an almost even split among proponents and opponents of flexible work models. These discussions have added further impetus to Mackey’s pessimistic outlook on the office market.
At the end of 2021, “office vacancy was 16% across the board in South Africa,” says Mackey, adding, “our portfolio was slightly higher than that – we were at 18.9%. We had slightly higher office vacancy than the average in the market in our small portfolio.”
“I don’t see them [vacancy numbers] improving; I see them worsening as office spaces and tenant lease terms that do not reflect current market conditions.”
Notwithstanding flexible work models, Mackey thinks the days of executives having large corner offices could be behind us. “That may not be appropriate anymore.”
The SAC CEO foresees corporates forgoing that old model in favour of hot desks and meeting spaces. “That is a different mix to what there was in the past,” he says.
In South Africa, office take-up correlates with GDP growth. Low GDP growth means higher office vacancies. The country’s medium-term growth projections of less than 2% do not bode well for office landlords. “That is why we believe this is a sector we should entirely divest from,” says Mackey.
“We only have circa 2% of our portfolio in offices, which we think we may be able to reposition for the current environment. And, in due course, which is our expectation, divest from it.”
“We were fortunate that a number of … [our] office properties were smaller office properties. There was still an appetite for owner-occupier and for smaller investors. We leveraged off that ability to sell. It’s not surprising that the remaining office that we have is our largest, attracting investors to buy this is going to be more challenging than what we managed to get [for the other properties],” he says.
Supply and demand
“Oversupply issues have […] restricted the sector’s performance as vacancy growth rates outstripped rental escalations, which in turn limits the investment appeal of the sector,” says Mieke Purnell, research manager at JLL, a professional services firm specialising in real state that has its sub-Saharan Africa head office is in Johannesburg.
- In addition to the unfavourable operating context, corporates have the added responsibility of environment, social and governance (ESG) considerations when looking at office spaces, says Purnell.
- Purnell has also noticed an increasing trend of the big companies being interested in buildings that meet ESG requirements. That is especially the case in Sandton and Rosebank.
“There is demand for quality properties. [There are] … newer and nicer properties in [Sandton and Rosebank]. Because rentals are down, it’s more affordable now to change space requirements, to take up a new space or move to different spaces,” she says.
Industrial and retail real estate
According to FNB’s Property Broker Survey-Market Balance for the first quarter of 2022, the industrial property market is still perceived to be the strongest of the three major commercial property sectors – industrial, retail and residential.
But disruptions witnessed in supply chains during the past two years have led to an acceleration of e-commerce take-up in South Africa. That, in turn, has forced retailers to rethink the logistics of stock storage and getting products to buyers.
Some companies – like fashion retailer Foschini Group – have plans to onshore their textile and fabric manufacturing needs back to South Africa from China.
“The Foschini Group … [will] need to store that stuff, so there’s demand from a storage perspective,” says Purnell. “In terms of the prime, high-quality, hi-tech stock that’s in demand, there just isn’t much available. That’s why it’s a competitive market.”
“The nature of listed real estate is that large investors are pension funds,” says Mackey. “They want a predictable and resilient distribution. We are focusing our South African portfolio to meet those expectations. Convenience retail is that.”
He continues: “There’s a high [grocery store] component in that and other convenience [stores], particularly pharmaceutical. These are defensive sectors and check non-discretionary spend. That part of our portfolio proved to be very robust through the pandemic, and [we] believe will continue to be.”
In their report, Purnell and co make a similar observation: “This sector has been the strongest performer for years and confirmed this position during the pandemic. While nominal rental growth within this sector continues to lag inflation (resulting in negative real rental growth), vacancy rates are the lowest among the non-residential property sectors, and demand fundamentals are the strongest in the context of current economic conditions.”
Nevertheless, Purnell and her co-authors forecast that “2022 is set to be a strong year from an investment perspective, with some major deals being negotiated. More REITs have started considering acquisitions again.”
Patrycja Kula-Verster, business development manager at the JSE’s capital market division, says that international trends could influence greater diversification in the domestic market.
For starters, international REITs have specialisations in casinos, farmland, data centres, logistics, co-working spaces, nursing homes and prisons. “These are a potential catalyst for greater diversification in the local markets and, perhaps, something to keep an eye out for as drivers in the local market,” says Kula-Verster.
From an equity perspective, specialisation has been driving new listings. In March, aReit Prop listed on the JSE’s main board. “aReit is a property group holding leasehold properties with a focus on the hospitality and medical sectors, allowing investors to gain exposure […] without the related expenses, risks and debt,” says Kula-Verster.
Kula-Verster also highlighted Afine, which listed in December 2021 – the first South African REIT dedicated to petrol filling stations – as another example of the specialisation trend.
Consolidation and innovation ahead?
“There has been talk regarding consolidation, particularity for the small- to medium-sized REITs. Those wishing to do so have the opportunity to raise capital off the local capital markets. Over the past couple of years, many REITs have invested in offshore exposure and, perhaps, some South African REITs may try to consolidate with funds that have foreign exposure,” says the JSE’s Kula-Verster.
Keeping in step with market developments and movements, the bourse has designed a product for non-JSE-listed property companies: the JSE Private Placement platform. “The offering aims to create a new funding opportunity for issuers and investors. The technology streamlines the capital-raising process by providing digital access to investment opportunities using next-generation fintech,” Kula-Verster continues.
With three months in operation, “the platform has attracted more than R5bn ($343.3m) in potential investments. […] As the investor pool grows, this is an opportunity for unlisted property funds to onboard their deals for their capital-raising needs,” says Kula-Verster.
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