The drama of empty offices and plunging rents could soon end with economic growth

Investors rushing into the listed property sector (see Companies) seem unconcerned that the funds are struggling to increase their incomes. They seem more interested in the sector's low-tax structure and steady initial yields.

SA's oversupplied office market is the last burden the property sector must shed on its way to complete recovery as a desirable asset class.

Offices make up an important part of many funds. Most have reported low or zero income growth this year because of falling tenant occupancies and rent levels.

But fund yields are falling with the growing demand, and fund managers must rely more on their office portfolios performing better. Its not easy.

Real rents in A-grade buildings have fallen so far - to nearly half what they were three years ago in some areas - that B-grade tenants find they can afford to move in. So B-grade offices have been hit hardest. In Claremont, Cape Town, some A-grade rents dropped to R40/m² last year, while B-grade rents have averaged R50/m².

The questions for investors are: what companies are most affected, and when will rents rise again?

Funds with high office exposure are Sycom (52% of its income at December 2002), ApexHi (51%), Atlas (47%), Growthpoint (45%), Hyprop (52%), Ifour (44%) and Redefine (52%).

Viruly Consulting partner Pauline Larsen points out that the office cycle is going through its classic phases on the way to recovery. "Oversupply has been followed by banks tightening up on lending," she says. "This has stopped further development."

For instance, in Johannesburg, new development has fallen from 243, 000 m² in 2001 and 60, 000 m² in 2002, just 1,5% of the occupied 4 m² in the region. The next phase will see empty space filling up, followed by rising rents.

Some areas are already beginning to turn. Durban's Umhlanga has only six months' space available at the current net take-up rate (see table), while Johannesburg's Rosebank has 25 years' worth of take-up available. Claremont is still losing tenants.

Cape Town's office market seems to have taken the most pain, with every major node deteriorating, says Dave Russell, director of estate agency Baker Street. "A number of listed financial services companies that moved to Cape Town in the 1990s have disappeared. Others - Southern Life, Norwich and Fedsure - have been swallowed in mergers. And Swiss Re moved to Johannesburg.

Nearly 40% of Hyprop's and Ifour's leases need renewing this year and next. So the performance of the office market could be important to them.

Russell thinks these renewals will miss the coming upswing. But only just. "The turnaround will definitely not come in the next 12 months," he says. "But it is likely in 18-24 months."

Larsen says investors should watch individual suburbs and their effect on specific companies - Sandton CBD and Sycom, or Cape Town and Atlas.

Russell expects the upswing to be general. "Once the economy starts improving, it will improve in all nodes."

But Larsen and Russell agree that the first signs of an upswing - and of fast-rising listed property yields - are coming into view.

Financial Mail