Implications of new rates and utilities tariffs for the property market

Implications of new rates and utilities tariffs for the property market

The heads of some major listed property funds have recently highlighted the challenge of municipal rates and utilities tariffs that continue to rise in excess of general price inflation rates.

This is becoming ever-more troublesome for tenants and property owners, as they contribute to operating costs eating into a rising portion of property incomes, according to the latest Property Insights note by John Loos, property sector strategist at FNB Commercial Property Finance.

"The situation has worsened in recent years with property income growth coming under pressure from the long-term economic stagnation. Further weakening in national property real values and heightened business migration in search of better deals appear to be the likely outcome. But it is debatable whether increased regional competition for household and business ratepayers can lead to improved service delivery in places," says Loos.

Economic growth

By its own historical standards, property in South Africa is still expensive, although it has been correcting slowly over time. It became expensive in the early-2000s due to massive interest rate reductions and a significantly improved business environment in the post-sanctions and boycott years. These factors combined boosted economic growth to above 5% just before 2008.

As a result, real (inflation-adjusted) rentals rose sharply, says Loos.

"Even if key operating cost items like council rates and utilities tariffs had increased at above general inflation rates, it would have mattered far less in those days because of the strength of the economy and commercial property rental markets. The market was far better able to absorb such cost increases at that stage."

From 1995 to 2015, the MSCI All Commercial Property Net Operating Income data - inflation-adjusted using GDP inflation - showed an increase in real inflation-adjusted terms by a massive 73.4%. The real net operating income for retail property, the long-term outperformer, had increased by an even more impressive 104.4%.

This meant that in the initial years of above-inflation increases in electricity tariffs and municipal rates as well as other tariffs, from around 2008, the property rental market was still strong enough for real net operating income to move broadly sideways from 2007 to 2015.

Electricity costs initially rose very sharply as a percentage of property income - from 6.4% in 2007 to 12.2% by 2012 - before levelling out to an extent in 2021. Property taxation costs as a percentage of property income rose more gradually. However, taxation also virtually doubled from 5.12% in 2007 to 10.35% in 2021.

Stagnation

The economy began its long-term growth stagnation around 2012, after a short recovery following the 2008 general financial crisis.

In a stagnant economy with declining real rentals, property operating costs have become more of an issue in recent years. As a result, demand growth for commercial space has gradually come under more pressure, vacancy rates have increased, and property rental growth has progressed more slowly.

This environment of economic stagnation makes operating costs far more of an issue than in the stronger years, says Loos.

"The tenant population has gradually become more financially constrained, and real rentals have declined. From the high of 2016, all property net operating income began to decline by a significant -19.8% cumulatively to 2021 in real inflation-adjusted terms. Real base rentals contributed to this with a -5.8% decline over the same period.

"This is a significant fall so far, and it probably isn't over yet. The result has been a cumulative real decline in average capital value per square metre of -26% over the same period, with more likely to come.

"In this weak economic and property rental market environment, rates and tariffs really start to matter far more to landlords and tenants. In addition to the high rates and tariffs, the quality of municipal and utilities services received in return is also an issue."

Prognosis

Loos says it is difficult to see above-inflation municipal rates and utilities tariffs ending soon. More downward pressure on real property net operating income and capital values is likely - in part from these key operating cost sources of pressure.

However, he also expects an increasing number of companies to be on the lookout for better rates, tariffs and services deals.

"In 2021, Clover decided to move its cheese factory in Lichtenburg to Durban, citing poor council water and electricity supply along with poor road infrastructure in the Lichtenburg area.

"That was just one well-publicised case, but it is realistic to believe that such geographic shifts in business activity will escalate in the near future. Many companies are increasingly financially constrained in the stagnant economy, and many councils are implementing above inflation rates and tariff increases while their services and infrastructure deteriorate."

He says that certain of the listed property funds are pointing to a region that appears to stand out above the rest in this regard.

"These property owners appear to be significantly more excited about the deal they receive in the Western Cape, a region that appears to be increasingly outperforming the rest in terms of service delivery, infrastructure, household and business investment retention and attraction, and economic and property market performance.

"For many years now, this region has been attracting strong net inflows of skilled and higher-income individuals from other provinces, as well as some businesses.

"It's difficult to say whether regional competitive pressure will drive a positive service-delivery and rates response from certain other councils and regions, to retain and attract businesses and individuals that they may have been losing.

"So far, the signs of such a development are not obvious. But greater competitive pressure between regions and councils for business and ratepayers does have the potential to drive service delivery and rates value-for-money in an improving direction at some future stage," says Loos.