South African property under pressure
As the economic environment toughens, electricity supply promises to be an important driver of regional competitive advantage as business and individuals search for locations where services are reliable.
South Africa’s electricity supply and cost issues have become increasingly important for the country’s property market in recent times.
This is not because the electricity crisis is something new, but rather because there are a host of other “economic negatives” that have been mounting.
The electricity crisis is extra-challenging currently because of other key operating cost items also rising rapidly.
The electricity supply crisis is not new. Load shedding first started in earnest back in 2008, as did the big electricity tariff hikes.
In fact, MSCI data shows that the major increase in gross electricity costs as a percentage of commercial property income receivable took place between 2007 and 2012, where it rose from 6.4% in 2007 to 12.2% by 2012.
In 2021 this percentage was not significantly different to 2012, measuring 12.4%.
Therefore, the biggest part of the electricity cost shock to property operating costs actually took place more than a decade ago.
It is actually another area of “government-related” costs that has become challenging to the property market more recently, i.e. the area of property taxation costs, largely relating to council rates.
As a percentage of gross income receivable, this cost item has risen from 5.12% in 2007 to 10.35%, according to MSCI data.
Therefore, electricity cost increases at the present time aren’t merely a challenge due to their own pace of increase.
They must also be viewed in the contest of an environment where certain other key cost items such as property taxes are also rising very fast.
The electricity crisis is also challenging currently due to the recent host of other economic negatives exerting pressure on property.
In addition, the timing of big electricity tariff increases gets progressively worse as the economy stagnates, and the economic stagnation is in part due to a deteriorating power supply. General inflation has surged recently, and interest rates are on the rise too.
Therefore, the tenant population finds itself far more financially pressured than pre-Covid 19 times.
According to TPN data, only 66.3% of commercial tenants were in good standing early in 2022 regarding their rental payments. In pre-lockdown times this percentage was often above 80%.
Therefore, while landlords can, in theory, recover electricity and other costs from tenants, in practice, a financially pressured tenant population means that something “has to give”. In many cases, it is rentals that have to decline, at least in real terms.
MSCI data does point to All Commercial Property rentals in decline in real (inflation-adjusted) terms, having declined in real terms by -8.3% since 2014.
And the All-Property Net Operating Income measure has declined in real (inflation-adjusted) terms by -19.9% since 2016.
The current financial time is thus a significantly tougher environment in which to absorb electricity tariff increases or cost increases associated with finding alternative reliable power supply sources compared with more than a decade ago.
The indirect impact of the electricity crisis on property
The indirect impact of the electricity crisis on property markets is difficult to quantify but easy to understand.
The erratic nature of electricity supply disrupts economy-wide production in a myriad of ways, and this in turn constrains GDP growth to lower levels than would otherwise be the case.
The rising real cost of electricity supply, too, hampers economic and business performance through raising the cost of doing business and thus reducing the financial viability of certain business.
Lower rates of GDP growth imply weaker business performance and business confidence, which in turn implies constraints on business expansions and new start-ups.
This in turn constrains the demand for commercial property space.
There is thus little doubt that the electricity supply crisis exerts pressure on property market performance, either directly via the property operating cost impact, or indirectly via the impact on the economy.
But what about regional market differences? This is perhaps the more interesting part.
The current environment in which the electricity crisis is playing out likely promises an even wider divergence in regional economic and property market performances.
The electricity crisis provides an additional opportunity for local governments to differentiate themselves and their regions from others.
Proactive councils such as City of Cape Town have already been achieving something of an economic competitive advantage over others through demonstrating relatively sound city management, a feature that has been attracting skilled and affluent “semi-grants” to the region.
These skills inflows should drive a superior economic and property market performance for Cape Town and the broader Western Cape region, something we appear to be seeing already.
More recently, though, City of Cape Town has also been attempting to differentiate itself in terms of often keeping load shedding at lower levels than the rest of the country through procuring power from independent sources to supplement Eskom supply in part.
This more reliable supply of power in Cape Town promises to be a further attraction for business and individual investors alike, and can further the region’s competitive advantage, and thus further promote a superior economic and property market performance compared to many other regions and council areas.
City of Johannesburg has also, in recent days, been emphasizing its plan to secure alternative sources of power supply to improve reliability.
What all this potentially means is that the electricity supply crisis could indirectly lead to a wider divergence between economies and thus regional property markets, those proactive councils attracting investment and skills to a greater degree than those who leave their fate in the hands of the power utility.
Electricity, therefore, promises to become yet another important source of council and regional competitive advantage (or disadvantage) as business and individuals alike increasingly search for regions where services are reliable. This has a potentially significant impact on relative performances of regional property markets.
On a national average basis, therefore, I would expect the electricity supply crisis, along with above-inflation electricity tariff increases, to contribute to the near-term real decline in commercial property net operating income as well as on real capital values, sustaining a broad declining trend that has been in play since around 2016.
On a regional basis, electricity promises to become a more important source of council and regional competitive advantage (or disadvantage) as businesses and individuals alike increasingly search for regions where services are reliable.
This has a potentially significant impact on relative performances of regional property markets. I believe that in the near term, this contributes most notably to City of Cape Town’s expected property market “relative outperformance”, but others such as City of Johannesburg may be following suit in future.
By John Loos, property sector strategist at FNB Commercial Property Finance