Hurdle rate comes down - Rode

Posted On Monday, 26 February 2001 02:00 Published by
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PROFIT expectations in the property industry are dropping in line with declining inflation expectations, says property economics and valuations firm Rode & Associates in its latest property state report.

PROFIT expectations in the property industry are dropping in line with declining inflation expectations, says property economics and valuations firm Rode & Associates in its latest property state report.

Rode's Report on the SA Property Market notes that the hurdle rate for prime property has now dropped to 19% after having been stuck at 20% for more than a decade. The hurdle rate is the minimum expected total return that investors demand to induce them to invest in a property project. Total return comprises income yield plus capital appreciation.

Report editor Khalid Mohamed says the hurdle rate is used as a discount rate to value properties with long leases, as well as a benchmark for minimum return for new developments. "The implication of the lower discount rate is that many property values will rise. Furthermore, the lower return expectations will eventually make more developments viable."

Mohamed says another barometer of the property industry state, capitalisation rates, have now attained their true equilibrium subsequent to large institutions' decisions in about 1996 to start trimming their property portfolios.

"This implies that capitalisation rates are not expected to fall significantly to pre- Asian financial crisis levels any time soon." Capitalisation rates are the property equivalent of the earnings yield of shares.

According to Rode's Report, office rental growth seems to have peaked for now in the wake of a growing oversupply. Grade-A decentralised real office rental growth reached its zenith at 9,8% in quarter 3 of 2000.

"Decentralised office vacancies increased in the fourth quarter of 2000, and the effects of this can already be seen in the capping of the rental growth rate. Still, real rentals in these areas are still growing at a very respectable rate of about 9%," the report says.

In contrast, real grade-A rentals in the CBDs closed 2,8% down on a year earlier. This is after having enjoyed positive growth since quarter 1998:4.

Real prime industrial rentals performed well during 2000, with the Central Witwatersrand leading the pack. An enhancing factor is the positive performance of manufacturing production - a proxy for demand for space - in the second half of 2000.

"Also, falling industrial vacancies in important areas added to this upward pressure on industrial rentals. Thus, the outlook for industrial rentals in 2001 is promising. However, the proviso is that the economy must achieve its targeted growth rates."

Rode reports that nominal flat rentals have enjoyed healthy growth through most of the second half of the 1990s, but this growth is fast slowing down. In fact, if this downward momentum continues, most cities could find themselves in negative territory soon, the report states.

For consumers in the middle and upper-class suburbs the news is good as house prices have pulled themselves out of their decade-long drought. This upward momentum is set to continue as the economy improves.

Cape Town showed the smallest increase in growth, but because the city's house prices grew from a high base, they are in fact still the highest in the country. "Cape prices are slowing down, maybe because they have reached equilibrium with replacement costs," says Mohamed.

As for the building industry, the year ahead looks slightly more promising. Real residential building plans passed in the first 10 months of 2000 are up by a whopping 22,9% compared to a year earlier. However, the non-residential building industry, as is customary for the current phase of the cycle, has still not shown any signs of an improvement yet

Publisher: Cape Business News
Source: Cape Business News

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