IT's good news for tenants but bad news for landlords as South Africa's leaseback escalation rate has fallen to below 10%. This is its lowest level since 1998, says Cape Town property economics and valuations firm Rode & Associates, and it means that new tenants can negotiate smaller annual increases in rent.

Rode's Report on the SA Property Market for quarter 2001:2 reports that the cause of this drop in the escalation rate is declining long-term inflation expectations, and hence declining expected market-rental growth rates. A leaseback is essentially a lease agreement longer than 10 years.

Good news though for residential landlords is that flat rentals are again accelerating. Erwin Rode, CEO of Rode & Associates, says the reason for this acceleration is that the high real interest rates have depressed additions to stock over the last decade. 'Moreover, the ongoing sectionalisation of blocks of flats has diminished rental stock, and the taxation of employer-subsidised mortgage bond interest has levelled the playing field between owning and renting.'

As for the residential home market, upmarket house prices are booming. This is normal for this phase of the business cycle since improvements in the economy are first reflected in the earnings of the more affluent.

Turning to industrial property, manufacturing production - a proxy for demand for industrial space - has been chugging along at a healthy growth rate of about 4,6% p.a. since the beginning of 1999. This is good news for industrial rentals, provided the economy keeps growing at about 3% p.a.

Despite rising vacancies, decentralised prime office rentals are generally growing at a healthy tempo, registering a real growth rate of about 8% compared to the same time last year. The rate now equals the growth-rate peak last attained in mid 1997.

Capitalisation rates largely moved sideways, with the exception of CBD offices, while regional shopping centres continued to show the lowest capitalisation rates, closing slightly up at about 11,4%. CBD office cap rates are down 0,4% points on the previous quarter (15,5%), while grade-A decentralised offices are marginally down, closing 12,9%.

Capitalisation rates are the property equivalent of the forward earnings yield of listed shares.

While the turbulence in the financial markets continues to pummel equity returns, the long-term outlook for a further rerating of property unit trusts (PUTs) remains good, Rode predicts.

Since the beginning of 1999, long-bond yields have been trending down. 'What is even more heartening is the fact that property unit trusts (PUTs) are faithfully tracking bond yields, suggesting that investors are viewing long bonds and listed property in a similar light,' says Rode. 'Furthermore, the gap between PUT yields and directly-held property's capitalisation rates is closing. The implication of this convergence is that there will be a deluge of listings of directly-held property portfolios over the next two to three years.'