Brokers perceive recovery in commercial market but levels well below pre-lockdown

FNB Commercial Property Finance has released its ‘3rd Quarter Property Broker Survey of Rental Market Conditions’. The survey samples commercial property brokers in and around the six major metros of South Africa i.e. the City of Johannesburg and Ekurhuleni (greater Johannesburg), Tshwane, eThekwini, the City of Cape Town, and Nelson Mandela Bay.

With a strong focus on the ‘owner-serviced’ market, FNB’s pre-requisite in selecting these broker respondents is that they deal in owner-serviced properties with a portion of these respondents also dealing in the developer or investor markets as well as in the listed sector.

FNB asks the respondents to provide a rating of the rental
market activity as they perceive it, on a scale of ‘1’ to ‘10’ with ‘10’ being
the strongest level of activity. Like FNB’s ‘buying/selling’ survey component,
the rental market survey component still shows the highest levels of optimism
(or least pessimism) emanating from the industrial and warehouse property
market respondents.

In this segment, the activity rating rose from ‘4.5’ in the ‘lockdown’
second quarter to ‘5.19’ in the third quarter survey. The retail sector also
saw some strengthening in its market activity rating from ‘3.62’ in the second
quarter to ‘4.1’ in the third quarter. However, the office sector’s activity
rating continued its decline to ‘3.66’, slightly down on the ‘3.7’ of the prior
quarter and now, the sector with the lowest rating of the three major
commercial property sectors.

Despite slight industrial and retail improvements, all three sectors’ levels remain well-below pre-lockdown first quarter activity levels.

The activity trend over the past six months

FNB asks a follow up question to the activity rating by asking respondents whether they believe the rental market activity has strengthened, weakened, or remained the same since six-months prior.

With the responses, FNB creates an index by allocating a ‘+1’
score to an ‘increased’ response, a ‘0’ to an ‘unchanged’ response and a ‘-1’
to a ‘declined’ response.

The scale of the ‘Index for Direction of Change in the Rental Market Activity over the past Six Months’ is from ‘+100’ to ‘-100’. A score of ‘+100’ would imply that 100% of respondents perceived an increase in time on the market over the past six months and a ‘-100’ would imply 100% of respondents perceiving a weakening, while a ‘0’ level would mean that those providing an ‘increased’ response equals those responding with a ‘decline’.

Of the three property classes, the industrial property survey returned the least negative, reading ‘-8’ implying that ‘8’ percentage points’ more of respondents perceived a decline in rental market activity than those who perceived an increase.

By comparison, the readings in the retail and office markets for this response were far weaker, office with a negative ‘-70’ and retail with a negative ‘-53’. Retail showed some quarter-on-quarter improvement, but the office reading remained unchanged in the second quarter.

The retail and office sectors’ readings remain far below the first quarter which was prior to lockdown and at a similar level to the weak readings of the second (lockdown) quarter. The industrial property reading, by comparison, bounced back more noticeably in the third quarter following lockdown.

Vacancy Trends

Using the same methodology as above, FNB compiles an index
on a scale of ‘+100’ to ‘-100’ for the responses as to whether vacancy rates
have risen, remained the same or declines over the past six months.

There is little to choose from between the property sub-sectors, with the respondents in all three sectors strongly biased towards a rising recent vacancy rate trend. In the quarters prior to the lockdown’s second quarter, all three sectors’ respondents were also biased towards rising vacancy rates but to a far less extreme degree. Since the second quarter of 2020, this bias has become far more significant.

The retail property sector had the most extreme third quarter
reading of ‘+90’, slightly up from the prior quarter’s ‘+88’, indicating that
90 percentage points’ worth more of respondents perceived vacancy rates to have
risen than those perceiving a decline.

The industrial property reading of ‘+64’ was the least
extreme of the three sectors while the office property reading was the second
highest with ‘+82’.

The aggregate perception of rising vacancy rates is very
strong across all three property sectors.

The strong broker perception of rising vacancy rates in the past two quarters’ surveys ties in with what TPN reported regarding tenant payment performance, which dipped sharply during the second quarter lockdown period.

From 77.85% of tenants being in good standing with landlords regarding rental payments in the first quarter of 2020, performance of commercial tenants dropped sharply to 50.36% in the second quarter. Brokers appear to be witnessing the impact of this sharp deterioration in the finances of the tenant population in the second quarter lockdown period, resulting in the likely closure or scaling back of a noticeable group of tenants’ businesses.

From an economy point of view, strong perceptions of rising vacancy rates suggests that complete economic recovery (to pre-Covid-19 economy-wide production levels) will be tough to achieve in the short term, because the economy-wide production capacity has likely been reduced. Rising vacancy rates may support this notion of decline in production capacity in especially manufacturing (strongly linked to industrial property), retail (linked to retail property) and certain services sectors linked to office property.

The office property sector has the added challenge of an apparent increase in remote working, enabling certain employers to scale down on office space even in the instance of business activities continuing.

Near term expectations: the Covid-19 impact still
features prominently on the list of issues.

Near term activity expectations amongst survey respondents
have most often in prior surveys been biased towards strengthening, when FNB
asks them to provide their six-months ahead expectations for rental market
activity (i.e. increase, decrease, or remain the same).

It is possible that there exists some inherent bias towards the ‘positive’, when brokers’ future expectations are surveyed, something also seen in forecasting economists’ reluctance to forecast bouts of negative growth that periodically happen. In the second quarter survey, however, such positive bias in the retail and office markets dwindled, reflecting a dire economic situation, but has returned to the office market in the third quarter.

In the third quarter 2020 survey, the industrial property
respondent group remained mildly biased towards strengthening, with a ‘+25’
index reading. Retail property moved from a prior quarter’s ‘-17’ negative
reading to a smaller negative reading of ‘-3’.

Surprisingly, the weak office Property moved from a negative ‘-25’ to a positive ‘+18’. While ‘market activity’ can refer to supply-side as well as demand-side activity, a rising activity rating usually correlates more with strengthening demand for space/property. Given all the remote work talk, a positive near-term activity expectation would be surprising in office space, although admittedly it is not a strongly positive number.

Key factors that drive near-term activity expectations

The factors that brokers cite as key influences on their near-term
market activity expectations are often insightful and have proved to be
interesting in the office sector survey for the third quarter.

While the Covid-19 lockdown impact remains strongly on brokers’ minds, it has become far less the economic impact of Covid-19, cited by only 6% of office survey respondents, and far more about the Covid-19-related remote working surge resulting in companies re-assessing their office space needs. This latter influencing factor was cited by a major 52% of respondents.

However, on the positive side, a significant 40% indicated
their expectation of smaller business demand for office space, somewhat
surprising in these tough economic times.

This is interesting. One thing that TPN tenant data by segment shows is that to date office property tenants have been least impacted by lockdowns, many having managed to work remotely and keep their doors open. But the question will be to what extent they suffer from the lagged economic impacts of lockdown that are still to come.

In the industrial property survey, where brokers are most confident about near term market activity, only 17% of respondents pointed to the negative economic impact of Covid-19 as being a key factor influencing their expectations. A more significant 28% point to expected small business demand for space, the relative affordability of Industrial Property being its advantage over the other property sectors, while 9% point to increased need for warehouse space as online retail grows.

Industrial property is thus not seen by brokers as being a
victim of technological progress that could reduce demand for space, such as is
the case in the office (remote work) and retail property (online retail) sectors.

In the Retail Property Survey, where respondents are most pessimistic about near term activity levels in the rental market, 37% of respondents cited the Covid-19 economic impact (implying an impact on consumer purchasing power) as a key issue, while 13% point to the online retail challenge to retail property.

Remote work in office property perceived as far more
significant than online retail in retail property

It is Interesting that relatively far fewer respondents have focused on online retail as a key driver of near-term expectations in retail property relative to those focused on remote work and downward revision of office needs in the office sector.


In short, brokers surveyed in the 3rd quarter FNB Property
Broker Survey perceived a slight post-lockdown strengthening in the industrial
and retail rental market activity levels from the second quarter, but a slight
decline in office market activity level. However, they perceive all three major
property sector activity levels to be still significantly below the
pre-lockdown first quarter survey levels.

Examining near term market activity expectations, in industrial
property and office property the broker group is biased towards strengthening,
while the bias is towards weakening in the retail rental market.

Concerns related to Covid-19, and its impact on property,
remain strong. In the area of office property, the biggest factor influencing
expectations is how companies revise their office space needs as remote working
increases in importance.

In retail property, the only segment where brokers on average
expect a near term decline in activity, the negative economic impact from Covid-19
lockdowns on the economy and thus the consumer is the single biggest factor,
with the challenge of online retail still a less cited factor.

But across all three major commercial property sectors the
brokers strongly perceive vacancy rates to be rising. This suggests downward
pressure on rentals in all three of the property sectors to come, which in turn
could be expected to translate into decline in average property values in the
near term.

In FNB’s forecast for ‘all commercial property values’, they have projected a ‘-7%’ average value decline for 2020, and following this most recent survey, they have kept this projection for the year unchanged.

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