Cape Town coming for Joburg’s crown

South Africa’s commercial real estate sector is under immense pressure, but Cape Town is bouncing back more strongly than its peers as its vacancy rates decline steeply and office rentals increase. 

Cape Town’s better service delivery ultimately positions it to gain ground on Johannesburg as the country’s economic hub. 

In the Oxford Economics Global Cities Index for 2024, Cape Town gained ground on Johannesburg as the country’s economic hub suffered from mismanagement. 

Joburg remains the best city in South Africa but dropped to 380th in the world, mainly due to its declining quality of life, which ranks 923rd in the world. 

The declining quality of life is largely attributed to failures in basic service delivery, from electricity to water and road infrastructure.

Joburg does punch far above its weight concerning human capital, ranking 39th in the world thanks to its world-class educational institutions.  

Second-best in South Africa is Cape Town, with an overall ranking of 445th. The city also punches above its weight with regard to human capital while falling behind on quality of life. 

Cape Town’s enhanced service delivery has also resulted in its commercial real estate sector bouncing back strongly from the pandemic-era lows. 

A high vacancy rate above the pre-pandemic level exerts pressure on office rental prices, the Reserve Bank said in its latest Financial Stability Review.  

Although there are signs of recovery in vacancy rates, they have yet to return to pre-pandemic levels, and this continues to exert pressure on real rental prices.

However, there are notable differences in trends among provinces. The trend of semigration to Cape Town has resulted in a stronger recovery in vacancy rates and real rentals for Grade A offices in the Western Cape region.  

The relatively quick resurgence in Cape Town’s commercial real estate sector is shown in the graphs below. 

Apart from the bright spot of Cape Town and the broader Western Cape, the Reserve Bank’s assessment of the commercial real estate sector found that instability within the sector has increased in the past few years. 

The findings indicate a decline in capital growth and transaction activity due to higher borrowing costs. Higher interest rates have also led to a deterioration in banks’ commercial real estate asset quality. 

While investors may incur large financial losses in the event of market shocks, systemic risks appear limited due to the relatively low direct exposure of the financial system to the sector. 

This is thanks to banks reducing lending to the sector as they experienced a sharp rise in bad debt as interest rates rose to 15-year highs before the Reserve Bank began cutting rates in September 2024. 

Although this is positive for financial stability from a bank credit risk perspective, it has contributed to growing financing challenges for the sector, the Reserve Bank said. 

It said the South African commercial real estate sector is under pressure, both from a cost and income perspective.  

From a cost perspective, significant investments in alternative electricity supply are required, and municipal rates and taxes have increased faster than rental income. 

Water supply is also a concern in some areas. Moreover, physical risks stemming from climate change present a significant challenge for the CRE sector, impacting property values and increasing insurance costs. 

The Reserve Bank’s study showed that construction activity is at an all-time low. Depressed asset values and rising construction costs have made many new developments financially unfeasible. 

The increasing pressure on the sector could result in a downward spiral, with banks continuing to reduce lending to commercial real estate developers, given their lacklustre financial performance. 

Commercial mortgages as a share of total lending continued on a downward trend in the post-pandemic period. 

Year-on-year growth in credit extended to the commercial real estate sector plummeted drastically in the first three quarters of 2020 due to the financial fallout from the effects of the COVID-19 pandemic. 

The downward trend moderated somewhat until the third quarter of 2021. As restrictions to economic activity were gradually relaxed, credit extension to the CRE sector regained momentum, growing at around 15% year on year at the end of 2023. 

The credit quality of CRE assets continues to deteriorate, albeit more moderately in recent months, as seen by a moderation in the specific impairments, the Reserve Bank warned.