The current property market has been affected by global financial problems with political and financial uncertainty at home. High interest rates and properties for sale offering unacceptably low returns are other reasons for muted investor interest. Listed Real Estate funds offer dividend yields in excess of 8% and immediate liquidity, 12 month Bank deposits offer in excess of 11%, “limit the risk” and the "cash is king" syndrome's again evident.
 
If one asked a seller, a buyer, a valuer, your bank or your property broker to assess a property it is likely that one would be given at least 5 different values. The price is determined not so much by assessing the correct capitalization rates but by properly assessing income and expenditure, which may be even more important than the capitalization rate.
 
Income
In a multi-tenanted property with 25 tenants, certain leases will continue with specific escalations, a few leases may expire and there may also be some bad payers. Does one assume that the leases that will be renewed and, if so, at what rental, and for how long? Is there an up to date tenant schedule to factor in escalations in the forecast period? Will all the forecast rentals be received? What are recoveries, if any?
 
Expenses
We have a schedule of property expenses with 37 main categories and 41 sub-categories, and a schedule of operating costs with 26 categories. Are the expenses realistic and correct? It is important to include the effect of expiring leases, commission payments, vacant periods and tenant installation costs in any calculation of expenses or income
 
If you get the above correct, how then do you apply a cap rate? If one of the tenants is a blue chip anchor with a 10 year lease, can you realistically apply the same cap rate to the video shop or take-away? The "risk" is not the same, the higher the risk the higher the capitalization rate should be.
 
Plans passed for new developments have slowed, the National Credit Act being a major reason. Also, most Bank's stringent, in our opinion unnecessarily so, credit policies are not helping either.
 
Developers with cash will find opportunity in buildings with upside in rentals, additional bulk opportunities or just more efficient management.  This is evidenced by recent sales of, amongst others, Stanhope Building in Claremont at R8 512 per m², and Oakhurst - Noyes in Kenilworth, the latter sold by Wall & Smith Property Consultants equating to R8 565 per m².  Both these sales involved Capitalization rates of less than 9%.
 
In these sales, returns were, from an investor point of view, unattractive.  Refurbishing an existing building with some rental income offsetting the cost of borrowing is also more attractive than developing vacant land with no income. Whilst both scenarios involve finance holding costs, regular building and labour cost escalations, unforeseen wet winter delays and an uncertain economic and political climate, buying and renovating an existing property has a great deal of merit.
 
Whilst taking all these factors into consideration, the appropriate capitalization rate is determined by a willing and able purchaser, for a property that offers capital growth opportunities with financially secure tenant/s. Notwithstanding the current financial turmoil, property will continue to be an essential part of any well structured investment portfolio.
Publisher: eProp
Source: Wall & Smith