Above the crowd: Office space continues to provide better returns

One of the best performing segments of the real estate sector over the past 12 months has been commercial office property. The office segment achieved an 11.2% overall return (income and capital) in 2012, the best performer outside industrial real estate and well above the sector average of 10.4% (retail had a return of 10.1%). Even so, the environment has still been tough for property managers in this segment, with doggedly high vacancies and increasing operating costs making life tough.

Resilience

As with the rest of the real estate market, the faltering international and domestic economy do not offer good news for the office segment. Nonetheless, despite modest GDP growth of 2.5% in the fourth quarter of 2012, businesses appear to have been able to weather this rough patch thus far. According to Statistics South Africa, liquidations were down by 39.9% to 194 in December 2012, compared to the same period of 2011. For the full year, liquidations were down by 23.7%.

The amount of gross leasable office space increased by 3.6% to 15.6m sq metres between the fourth quarter of 2011 and the same period of 2012. During this time, the overall vacancy rate also increased from 10.4% to 10.6%, according to Investment Property Databank (IPD) research conducted for the South Africa Property Owners Association (SAPOA). For new office developments, the vacancy rate stood at 47.3%, although this was down on the fourth quarter of 2011, when it was 52.9%.

All this points to a slowdown in a segment that has offered decent returns for developers, property managers and investors over the past decade. According to research by François Viruly, associate professor in the Department of Construction Economics and Management at the University of Cape Town, office rental inflation has averaged 6.1% over the past decade and 9.9% over the past five years. In the fourth quarter of 2012, the median gross rental rate for Grade A office space in the Johannesburg CBD was R70 ($8.53) per sq metre, while in the highly sought after Sandton node, it was R145 ($17.68) per sq metre.

External Costs

According to the IPD, operating costs in the office sector increased by 9% in the first half of 2012, compared to the first half of 2011. As a percentage of income, they increased by 1.9 percentage points. Electricity remains the most burdensome cost, accounting for 33% of total costs, followed by taxes (20%) and management costs (10%). Perhaps the most prominent challenge is the spiralling utilities costs. While these are already burdensome, Eskom, the primary generation, transmission and distribution company, was seeking to introduce a new annual 16% electricity tariff increase for the next five years in 2013. This was ultimately rejected by the National Energy Regulator in favour of a more manageable, but still notable, 8% annual tariff increase.

Another positive ruling for property owners occurred in November 2012, when the Supreme Court ruled that the City of Johannesburg’s 18% property tax rate increase introduced in the 2009/10 budget was invalid as a result of a lack of public participation. While it is still unclear whether the ruling will have positive financial implications for commercial property owners, it certainly sets a precedent that will create more transparency and stability throughout the country when it comes to new taxes.

Remaining Issues Ahead

Nonetheless, there are still outstanding issues and concerns for property owners. Given the cost burden of escalating rates and taxes, as well as utilities charges, the prospects for business and commercial property development are not particularly rosy. Currently, developers are beginning to direct their gaze outside the country and explore the rest of the continent.

Neil Gopal, CEO of the SAPOA, told OBG, “Our members are looking across the border. There are opportunities in other African countries, but these come with risks as in any country – and it is advised that you do your homework before you take the leap.”