It’s not only home buyers who are finding it more difficult to qualify for a mortgage these days. Commercial property lenders have also adopted a more cautious approach in a bid to keep bad debt under control.

Though SA banks have nowhere near the level of distressed commercial property loans on their books as their UK, European and American counterparts, the local industry is grappling with its own challenges, says Absa Commercial Property Finance head Mike Mortimer.

Fluctuating property values, coupled to rapidly rising operating costs (electricity tariffs and municipal rates in particular) that are generally outpacing rental escalations make it difficult to accurately project net income returns.

Mortimer says retail, office and industrial tenants’ ability to absorb rising utility costs has become unpredictable, which in turn makes cash flow difficult to sustain.

“These uncertainties weigh heavily on commercial property investment and development decisions and have forced us to become more prudent in our lending practices. It means that the focus has shifted away from the traditional loan-to-value criterion to cash flow.”

The track record of the developer or buyer has also become key. “We will only back experienced jockeys,” says Mortimer. Commercial property lenders are also pickier about the type of properties they are willing to finance.

Absa, for one, is staying away from vacant land, hotels, leisure property developments and golf estates. Mortimer says shopping centres in many of the smaller, coastal towns are also taking pain in a depressed holiday home market.

The latest performance figures from the SA Property Owners Association and IPD confirm that it’s becoming more difficult to make decent profits on commercial bricks-and-mortar investments. Total returns on commercial property slowed to 4,3% in the first half of 2011, less than a third of the 13,3% achieved for 2010 as a whole. Offices and retail buildings notched up growth of 4,6% and 4,5% respectively while warehouses and factories lagged behind at 3,6%.

IPD measures the investment performance of listed and directly held commercial property portfolios in SA collectively worth R94bn.

IPD managing director Stan Garrun says the weaker performance of SA commercial property is a reflection of an overall slowdown in the economy. Vacancies across the office, industrial and retail sectors have recently started to rise again, putting pressure on rental growth.

Garrun says latest IPD results show that SA is not immune to global uncertainty. He adds: “In SA we have also had to deal with difficult local issues, most notably rising costs. The protection of income streams is therefore at the forefront of property owners’ minds.”

Garrun expects little, if any, growth in commercial property values until the oversupply of space is mopped up. “In the near term, market performance is likely to be hesitant at best.”

Property economist Erwin Rode singles out the office market as the most lacklustre. “Uncertain economic conditions are obviously affecting business confidence. Firms must be thinking twice about expanding their premises or hiring new staff,” says Rode.

According to Sapoa figures, office vacancies across SA reached a new high of 10,2% in the third quarter, a level last seen in the early 2000s. Pressure on commercial property returns means that investors with a longer-term view can now pick up buildings at reduced prices on auction floors.

Auction Alliance CEO Rael Levitt says though prime commercial properties with quality leases in place are still selling at yields in the 8%-8,5% range, secondary buildings are available at yields as high as 15%. (The higher the yield the lower the price and vice versa.)

FINANCIAL MAIL