Will 2024 be a better year for commercial property? In some ways we expect so, but improvement may only reflect in 2025 numbers, with various economy-property market “leads and lags”, and risks remain abundant.
It’s that time again, early in the new year, when we are speculating as to what 2024 may hold, in this case for the property part of the South African economy.
We believe that the economic environment linked to the property market will improve mildly, but with various traditional “leads and lags”, this may only reflect in improved total property returns next year.
FNB expects Economic growth to improve slightly, from 0.8% in 2023 to 1.2% in 2024. As global inflation eases, we expect to receive some benefit from improving global economic growth. Domestically, power disruptions have been less severe in recently, compared to earlier in 2023, and the FNB assumption is that this will remain the case in 2024. In addition, mild interest rate reduction is forecast to start in the 2nd half of this year. After a mild rebound in CPI (Consumer Price Index) inflation in October 2023 to 5.9% year-on-year, the rate slowed once more to 5.5% in November, remaining inside the SARB’s 3-6% target range and well below the 7.8% high reached back in mid- 2022. Given that the inflation rate is still near to the SARB’s upper target limit, we don’t expect interest rate cutting just yet, but rather later in the 2nd half of the year.
Average CPI inflation for 2024 is expected to slow from 5.9% in 2023 to 5.2%. This, we believe, will lead to a moderate 75 basis points’ worth of interest rate cuts this year, Prime rate declining from 11.75% to 11% by year end.
Inflation forecasts don’t come without risks, however, a key one being the Middle East conflict. Recent attacks on shipping in the Red Sea, and the resultant military response from the US and UK, pose risks to global supply chains, thus posing inflation risk. In addition, the broader tensions in the Middle East, including the Israel-Hamas conflict, pose an ongoing upside risk to oil prices should the conflict situation widen further.
For the time being, however, oil prices remain relatively “well-behaved” at below $80/barrel (Brent Crude), not exerting major inflationary pressure.
Given a mildly improved outlook for growth and interest rates, it is conceivable that the commercial property market’s performance begins to improve mildly too in certain ways.
The movement of interest rates sideways since May 2023, after a significant prior hiking cycle, and the prospect of interest rate cuts later in 2023, is expected to see credit driven property buying/sales activity begin to recover during 2024 after last year’s interest rate hike-driven slowdown.
However, it may be that rental space demand in commercial property takes a little longer to improve.
Property Insights
The rental market component of the commercial property market has seen considerable improvement following the 2020 lockdown “shock”. The All Property Vacancy Rate of MSCI declined from a high of 9.5% in the 1st half of 2021 to 7.2% by the 1st half of 2023, according to MSCI half-yearly data. This was due to declines in vacancy in all 3 major commercial property sectors, even the beleaguered Office Market.
But vacancy rates can often lag economic fluctuations. The All Property Vacancy Rate peaked in the 1st half of 2021, a year after hard lockdowns, while the rise in vacancy rates in response to the 2009 GFC (Global Financial Crisis) only peaked around 2011. We would thus expect some possible renewed increase in the average All Property Vacancy Rate in 2024, before resuming its declining trend in 2025. This brief renewed rise in average vacancy rate would reflect the lagged financial impact on the tenant population resulting from the 2021-2023 interest rate hiking cycle, along with a slower economic growth rate last year compared with 2022. It could serve to exert pressure on rental growth and thus on property income in 2024.
This leads us to expect Total Return on commercial property to slow further in 2024, after a likely (data not available yet) slowdown in 2023, only responding to an economic improvement this year with stronger total returns in 2025.
In short, we expect the property-related economic environment to improve mildly in 2024, but this may only reflect in improved overall annual property performance figures in 2025.
Indeed, we had seen half-yearly All Property Total Returns (MSCI data) begin to decline in the 1st half of 2023 after prior post-lockdown strengthening, from 5% in the 2nd half of 2022 to 3.5%. This decline was expected following significant interest rate hiking and economic slowdown at the time.
The long term “correction” in real commercial property values is expected to continue in 2024. By “real’ we mean that any capital growth that there may be will likely not keep up with general inflation, thus declining in “real” terms. By 2022, the real (inflation-adjusted) All Property average capital value per square metre had declined by -23% since high reached in 2015. This significant
real value decline is in response to real net operating income also having declined significantly, with stagnant economic growth since a decade ago unable to support positive real net operating income growth., the latter which has thus also declined considerably since around 2015.
A key 2024 theme in commercial property is likely to be the municipal and utilities service reliability yet again.
Municipal rates and utilities tariffs continue to rise at rates well-above general inflation, a further source of pressure on net property operating income. While we do assume a better year for electricity supply, we expect that the search for areas and regions where “things work” is likely to remain a key feature in the current market in 2024, causing considerable household and business activity “semigration” to continue.
The Western Cape is expected to be a key beneficiary of this “semi-gration”, its economy and thus its property market expected to continue to outperform the rest of the major commercial markets in 2024.
With regard to the relative performances of the major 3 commercial property classes, we expect the status quo to remain, Industrial Property to be the relative outperformer, Retail in the middle, and the Office Market the weakest market. The Office Market remains the market with the biggest challenges, its national average vacancy rate remaining very high despite some recent decline.
In summary, the economic news is not wonderful yet, but there exists some promise of a mildly improved economic environment in 2024. Declining interest rates in the 2nd half of 2024 could serve to strengthen property investment at that stage. But given typical lags between economic improvements and resultant improvements in property performance, it is possible that this improvement would be reflected in overall annual property returns in 2025. The Western Cape region is expected to be the outperforming major region property-wise, and Industrial Property remaining the best performing major property class in 2024.
by John Loos, Property Sector Strategist at FNB Commercial Property Finance
