Improved outlook for
South African property
sector as tailwinds emerge

The reduction in political risk following the positive election outcome in RSA, a decline in loadshedding, a lowering inflation trend and the commencement of the interest rate cutting cycle has provided tailwinds to an improved outlook for the property sector.

The South African Property Index achieved a total return of 5.3% for the 6 months to June-2024 (vs 4.9% for the 6 months to June-2023), comprising of a 4.2% income return and a 1.1% capital return. Despite a tough operating and macroeconomic environment, property operational metrics have sustained a robust performance YTD, with vacancies and rental reversions continuing to show a generally improving trend.

The retail sector (comprising 62% of the MSCI index, by value) delivered another strong performance, achieving a total return of 5.1% (vs 4.3% in June-2023). According to the South African Property Owners Association (SAPOA) Retail Trends Report for 2Q 2024, annualised trading density growth (ATD) continued to moderate, slowing to 5.3% for the quarter from 6.2% in the previous quarter. This comes as little surprise given pressures on consumer disposal income, but we do expect this financial strain to somewhat abate given the softening inflation trajectory and easing of interest rates while withdrawals from the two-pot retirement system could provide a boost to consumer spending.

Retailers’ cost of occupancy is now at the healthiest level in 12 years, according to SAPOA, with gross rentals constituting 6.8% of tenant sales turnover (as at 2Q 2024). The continued improvement in occupancy cost ratios coupled with low retail vacancy rates has driven a sustained improvement in rental reversions on average with an increasing number of listed property landlords reporting positive reversions within their retail portfolios.

The industrial sector (12% of the MSCI index) continued as the best performing domestic property subsector delivering a total return of 7.4% (vs 5.4% in June 2023). The sector continues to benefit from low vacancies and sustained tenant demand for space. The logistics and warehousing subsegment has benefitted from the increased focus on supply chain optimisation, omnichannel strategies and growth in e-commerce. Rental reversions continue to narrow as higher borrowing and building costs, coupled with continued robust tenant demand, have put upward pressure on market rentals.

The office sector (21% of the MSCI index) remains constrained but has shown glimpses of improvement. The sector delivered an improved total return of 4.1% (vs. 0.9% in June-2023). According to SAPOA’s 3Q 2024 Office Vacancy Report, office vacancies reduced to 13.6%, the 9^th consecutive quarter of improvement. This improvement however continues to come at the expense of rental growth, with landlords having to provide attractive rentals and generous incentives to retain existing tenants and attract new tenants. A flight to quality continues to play out, supported by a narrow rental gap between prime and A-grade offices. P-grade office vacancies showed the largest improvement over the past year, improving 200bps to 7.5% as at 3Q 2024, according to SAPOA. There is a large divergence between nodal occupancies, with SAPOA reporting a vacancy rate of 5.7% for the City of Cape Town, significantly better than 16.3% recorded for the City of Johannesburg, as at 3Q 2024. Semigration and rising demand from business process outsourcing (BPO) companies have contributed to Cape Town’s outperformance. While subdued office development activity should aid in suppressing vacancy rates, we remain of the view that meaningful economic growth is a prerequisite to driving a resurgence within the office sector.

The listed property sector has rallied YTD with the FTSE / JSE SA Listed Property Index (SAPY) and the FTSE / JSE All Property Index (ALPI)) achieving total returns of 30% up to 3Q 2024 outperforming SA equities16% and SA bonds 16.7%. The strong rally in our view has been supported by a contraction in long bond yields as a result of a reduction in the political risk premium following a positive election outcome, improved fiscal outlook and generally positive updates/results from listed property players, with most guiding to an improved growth outlook.

The performance published by MSCI and the improved growth outlook by listed property players suggests that the South African property sector is well placed at this point in the cycle and we remain optimistic that the positive momentum can be sustained given the improving property fundamentals.