Taking stock: Demand for office space expected to follow economic recovery

Although the country has avoided the worst aspects of the global downturn, business confidence has been hit and many of the key indicators for business growth and subsequent office demand do not look promising.

South Africa’s GDP growth is expected to be 2.7% in 2012, down from 3.1% in 2011, according to the 2012 budget speech. This lower estimate follows earlier cautious projections by the IMF, which suggest GDP would grow only 3% in 2012. A steady improvement in the economic outlook would bode well for the development and rates in the office segment, although developers and investors may have to remain patient.

RECENT DEVELOPMENTS: Over the past 24 months, the supply and demand dynamics in the market have become skewed, as the appetite for office space has diminished. The starkest manifestation of this trend was the huge leap in the number of liquidations of companies and closed corporations in 2009. In that year, South Africa witnessed a 25.2% increase in the number of liquidations, and while there was a slight decrease in 2010, the figure remained well above the average level for 2005-08, according to Statistics South Africa.

In line with the improving economic situation, liquidations fell by 10.8% in 2011, suggesting the drop in demand for office space may be coming to a halt. However, there is little evidence that this has manifested itself in the market yet. According to the South African Property Owners Association and Investment Property Data Bank “Office Vacancy Survey Quarter Four 2011”, vacancy rates across South Africa’s 49 business nodes continued to increase, reaching a two-year high of 10.4%, up from 10.2% in the third quarter. Many vacancies seem to be driven by smaller firms, as grade-A space and grade-P space, defined as new-build units, have much lower vacancy rates, standing at 8.5% and 2%, respectively, in the last quarter of 2011.

According to Malcolm Horne, the CEO of Broll, a local CBRE affiliate, “Office space vacancies are high, but compared with levels seen in the rest of the world, it is certainly nothing to be overly concerned about.”

According to Broll, rental rates for grade-A office space in the central business districts of the country’s major cities, with the exception of Durban where rates have increased to 20%, have shown little decline in the past two years, but have rather plateaued, hovering around R75 ($9.80) per sq metre per month in Johannesburg, Durban and Pretoria.

CAUTIOUS OPTIMISM: There is a residual caution in the market, as companies and tenants take stock. This is evident in the South African Chamber of Commerce and Industry’s Business Confidence Index, which dipped to 97.1 (with base year 2005=100) in January 2012, the lowest level since May 2010. According to a statement released with the results, “Various challenges cloud the economic and business outlook for 2012 including lower economic growth, unemployment, higher inflation and weak municipal service delivery.”

This caution can also be seen in tenancy trends. According to Samuel Ogbu, the CEO of Liberty Properties, “With densification of areas such as Sandton, Melrose Arch and Rosebank [in Johannesburg], we will see more office space. But we’re also seeing renovation of old office space. It’s becoming more open plan and there is more efficient use of space to manage costs with less sq metres per employee. This is one of the factors that is slowing the absorption of office space.”

In the medium term, many analysts are optimistic that demand for office space will pick up; however, they caution there are still impediments to growth. “The underlying factor is that a lot of property owners and developers want to operate in an environment where local authorities are functional. This will be one big issue that defines demand in the future. Furthermore, rents are being driven by utility costs and municipal rates. The main inflation on rental rates is being driven by this… [which] could increase vacancies,” said Neil Gopal, the CEO of the South African Property Owners Association. Although the economy may be picking up, there are several challenges facing the office segment, which should bring caution to commercial developers’ plans.