RETAIL PROPERTY SETTLES INTO MEDIOCRITY
WORDS: SHIRLEY LE GUERN
The retail space is a lot more stable but it is not shooting the lights out and real correction still continues. This was just one of a number of mixed messages from First National Bank property economist, John Loos, at the first FNB Commercial Property Finance Quarterly Briefing of the year (February 2).
Focussing on both current retail property themes and prospects for 2022, Loos pointed out that, of late, the retail property market appeared to have been the “middle of the road” performer, sandwiched in between the underperforming office property market and the outperforming industrial property market.
“The retail property market is in an interesting space at the moment. It has come back reasonably well from the hard lockdown of 2020. It was the hardest hit of the major commercial property sectors during that year but it has come back to a position of mediocrity in a lot of ways which is better than where it was,” he observed.
Included in the structural changes that are inevitable is a resetting of the high capital value of retail property that had already begun in 2016, well before the arrival of the Covid pandemic.
THE DARLING PROPERTY CLASS
Loos said that, when analyzing this property class’s prospects, it was important to point out that it remained a relatively expensive property class by historic standards. Since the mid-1990s, it had seen very strong rental inflation, operating cost inflation and capital growth.
Using MSCI annual data, adjusted for general inflation in the economy to get to “real” values, real retail property net operating income (inflation adjusted using GDP inflation) had fallen by -20.9% from the peak 2015 level to 2020, while real capital value per square metre had fallen -18.8% over the same period. However, these real values in 2020 were still a massive 60.2% and 72.3%, up respectively on 1995 levels.
According to Loos, much of retail property’s meteoric rise in real rentals, income and values came during the consumer boom years prior to the Global Financial Crisis (GFC) recession of 2008/9. Interest rates had been reduced sharply from the late-1990s, consumers with far lower indebtedness levels back then went on a credit-driven spending spree and economic growth was an almost unthinkable 5%+ in the years just preceding the GFC.
The pre-GFC economic and consumer environment justified a sharp rise in real retail property rentals and values. It was the “darling” property class, as one would expect in a consumer boom, he noted.
However, after a post-GFC decade of economic growth stagnation and gradually rising financial pressure on consumers, this property class was due for a significant correction in its values, in order to better reflect economic fundamentals.
Loos said it was important to understand that this had begun six years ago and was not linked to Covid and should not influence the longer-term big picture of the so-called “post-lockdown” world.
A RETURN TO MEDIOCRITY
On the face of it, the news was good for retail, he continued. Almost all the important economic and other data related to the Retail Property Market pointed to a far better situation in 2021 compared to 2020. But the myriad of structural challenges faced by the South African economy suggested aa return to “mediocrity” at best.
Loos explained: “TPN tenant payment performance data tells us that retail property tenants were worse affected than the office and industrial tenant populations during the 2020 hard lockdowns and, despite having recovered to where 66% of tenants were in good standing with landlords regarding rental payments by July 2021, a massive improvement from 41% in May 2020, the level remained well below the 71% measured just prior to lockdowns commencing late in March of 2020. In addition, by October 2021 the tenants in good standing percentage had receded slightly to 64%, suggesting that the last part of the full recovery may be the toughest part of the recovery, and the percentage remains below the 71% of the Industrial Market and 70% of the Office Market.”
Better tenant performance would drive positive net income growth and see property capital growth move back into positive growth improve – but, it remained in negative territory as soon as these figures were adjusted for inflation.
Loos said that the 2022 economy was expected to reach “fully recovered” status – meaning that it would return to 2019 levels of real GDP (Gross Domestic Product).
“Some stability has returned to retail sales overall thanks to normalised economic activity because curfews have been lifted and lockdown regulations relaxed. The vaccine roll out, I assume, will keep it that way. A rising vacancy rate trend may reach its peak during the course of the year – but the still high vacancy rate means it is too soon to stop pressure on rentals just yet,” he warned.
DAVID VERSUS GOLIATH
Another trend which had begun to emerge prior to the Covid crisis but gained momentum over the past two years, was positive growth of neighbourhood and community shopping centres as opposed to super-regional, regional and small regional malls.
“During the first half of last year, the super regionals, regional and small regionals were worst off. They took a bigger income hit than the neighbourhood and community centres which were in positive growth territory at that stage. However, if you look more recently, you start to see that, off a lower base, the regional malls are growing faster. This could be a sign of things to come. The bigger centres are starting to come back more strongly off a lower base as they become more popular destinations once again.
“A lot of regional and super regionals sell luxury stuff or host eat out of cinemas. Those took a bigger hit than the essential grocery shopping items. Neighbourhood centres were therefore in a better position during lockdown.”
However, Loos remains sceptical and said that larger centres had some way to go. When figures were adjusted for inflation, they showed that, despite a recovery, the bigger centres were still in negative territory when compared with two years ago.
He said the scenario of smaller centres outperforming larger centres was a longer term issue which was likely to continue. Larger centre still had to reinvent themselves in various ways, he said.
Loos believes that consumer constraints will remain significant, impacting negatively on the short term prospects of retail property.
Real GDP growth is projected to recede in 2022 from 4.8% in 2021 to 2.2%, constrained by the higher GDP base of 2021 compared to 2020, as well as by rising interest rates. Real Household Disposable Income growth is forecast to be even slower at 0.2%, after an estimated 2.8% last year, constrained by very weak employment growth, rising interest rates and rising effective personal tax rates.
So, while less Covid-19 restrictions and concerns are a positive boost for less essential retail spending, the ongoing financial constraints of households still pointed to non-essentials underperforming more essential food, grocery and health item spending.
High unemployment remained a major constraint when it came to household disposable income and, after a brief spike off a low base during the second quarter of last year, employment growth in a more normalised economy settled back to minus 2.8%.
“Employment growth looks pretty grim still and we expect this to continue throughout the course of this year. A lot of companies who are trying to repair their balance sheets and profitability are loathe to employ but are rather trying to improve productivity as best they can with the employees that they’ve got. So, the squeeze on employment will continue for quite some time,” he predicted.
He added that job losses and job insecurity was creating an ultra-cautious consumer.
“We have a more cautious spender and a rising savings rate because of what consumers see around them – and it’s not pretty yet. It’s still a tough environment…. The more cautious spender and bigger saver is constraint for retailers. It is not what they want in the short term.”
Loos’s list of negatives which would keep shoppers’ hands firmly in their pockets was a long one – a further three expected interest rate hikes as the South African Reserve Bank adjusted ultralow rates to more realistic levels now that the country was no longer in crisis, rising inflation, hikes in municipal service charges and rates as well as taxation increases painted a pretty dismal picture.
“The 2022 expectation, in a nutshell, is one of significantly improved retail property performance from the past two years, but still a mediocre one with ongoing gradual real value correction, influenced by an economy vastly different from the pre-2008 boom period. That would seem realistic in the current period of long-term economic stagnation (looking longer term than Covid-19),” he concluded.