It is no secret that the office sector remains highly distressed and extremely competitive across the country. This is a concern, and given the current socio-economic conditions in the country, we are unlikely to see a significant recovery any time soon. It is important to note that there was already a considerable oversupply of office space in the market prior to the pandemic; hence, despite the easing of the pandemic, recovery is likely to still take several years. Some property funds have lost up to 20.00% in terms of Total Property Returns in the last 12 months. On the upside, the depressed market offers some good buying opportunities.
The Rental Market:
Tenants are reducing space by adopting a hybrid model and using hot-desking, which in turn reduces other landlord/fund revenue streams, e.g. parking. These changes have arisen not necessarily because CEOs find working remotely ideal but because of financial pressure on companies looking to downsize. This impact on the landlord/property fund is slightly offset by the need for additional meeting rooms, open spaces, and spaces allowing for virtual interactions. Most property funds and big private landlords are focusing on selling properties in nodes no longer desirable for office space e.g. Rivonia, Sunninghill.
- Increased vacancies: current vacancies of 35% in Gauteng. These distressed vacancy levels (>20.00%) are not limited to Gauteng.
- Increased WALES: tenants have used discounts, deferrals and other mechanisms well to secure longer-term leases.
- Decrease in escalations: Some built-in escalations are as low as 5.00% vs. 7.00% and 8.00% historically.
- Negative rental reversions: some property funds have reduced rentals by as much as 40.00%.
- The increase in bad debt seems to be stabilizing.
- Discounts granted: Despite the perceived improved 2022 trading period, some funds have increased discounts granted by as much as 20.00%.
- Low tenant retention rates: Tenant retention rates were as low as 50.00% in some instances.
- Increase in vacancy periods: buildings can stand empty for periods as long as 12 to 18 months.
How landlords can minimize vacancies:
- Offering discounts and other benefits to negotiate longer-term leases.
- Offering flexibility in terms of lease term and number of parking spaces.
- Providing fit-out allowances including furniture.
- Creating and facilitating collaborative working in very unique and creative ways.
- Reducing deposits.
- Increasing rent-free periods.
- Offering renewal benefits.
- Making buildings “green” (sustainable and more efficient).
Selling office space in the current environment is not easy. Hence, applying creative strategies to monetize at the best price is critical. Strategies could include:
- Sectionalizing and selling to occupiers.
- Converting to residential.
- Offering rental guarantees.
- Vendor financing.
The office sector is distressed. Banks require long WALEs, high LTVs and conservative covenants. However, nothing lasts forever, and investors specializing in offices can use this opportunity to secure the best-located office space with a competitive offering in the best nodes in South Africa. The sector offers value with office space trading at comparable prices to industrial properties on a per square metre basis, despite the replacement cost of office space being double the price of industrial space. However, risks (especially liquidity) need to be managed since no one wants to become a forced seller. Special attention must be placed not only on nodes but also on the offering. Office property is essentially a service after all.
Anvil Property Smith have various range of offices to let in South Africa and we could also assist sellers in formulating strategies to exit.
Author: Jeandré Pike