Source: SAPOA retail trends report, Catalyst Fund Managers

Based on monthly trading statistics, the sharpest declines in retail sales corresponded with the implementation of the harshest lockdown restrictions. As restrictions have eased, we have started to see a general improvement in the year-on-year comparative. On a 12-month annualised basis as at September 2020, trading density declined by 13.4% year on year. Analysing the decline further indicates that there has been a change in consumer behaviour as over the period foot count declined by 19% while spend per head increased by 7%. It is still too early to ascertain whether this increased basket size will become a permanent change.

Source: SAPOA retail trends report, Catalyst Fund Managers

Retailers cost of occupancy (gross rental to sales) has increased sharply as sales plunged with the advent of lockdown restrictions while gross rentals (as per contractual agreements) remained stable. Retail landlords granted significant rental concessions and deferrals over the lockdown period however this relief is temporary, and a normalisation of retailers cost of occupancy would depend on a rebound in trading conditions.

Source: SAPOA retail trends report, Catalyst Fund Managers

Despite significant rental relief provided to assist tenants, we still witnessed an increase in vacancies across all shopping centre types. During the lockdown period smaller format retail outlets outperformed as consumers avoided the large malls and directed their spending power to their local neighbourhood and community centres. In this regard, the spike in vacancies for these formats seems surprising; however, it is important to be cognisant of the tenant mix which does have exposure to SMME and service tenants.

Over the year, Edcon entered business rescue and ultimately the business was sold to Retailability and Foschini. Edcon was one of the last department stores still prevalent in local shopping centres following the demise of Stuttafords in 2017. The department store model has been under pressure globally for several years; however, the Covid-19 pandemic appeared to deliver the final blow as we saw not just Edcon enter business rescue but also Debenhams which is Britain’s largest department store chain. Structural changes already present have accelerated during the year and we expect an increasing amount of capital to be invested into online platforms by our local retailers. While we expect a rise in online shopping, quality retail centres will still have a critical role in any economy as part of an ongoing evolution to a world of omnichannel retailing.

Source: SAPOA office vacancy report, Catalyst Fund Managers
Data is as at 31 December 2020

The domestic office sector was poorly positioned going into the crisis; however, over the lockdown period it proved more resilient than other traditional sectors as reflected by collection rates during the period. Growthpoint reported collection rates on its SA office portfolio of 92%, 85% and 88% for the months of April, May and June respectively which was above the other sectors.

This resilience has started to unravel as the impact of corporate failures and downsizing has led to a marked increase in vacancies with national vacancies ending the year at 13.3% which is the highest since 2004.

Source: SAPOA office vacancy report, Catalyst Fund Managers

The deterioration in office vacancies has been felt across the different grades and indicates a softening of the market rather than pressure on a specific node or office grade.

Many companies had chosen January 2021 as an initial date to start the re-occupation of the office market; however, with the advent of the second wave this has further delayed that decision and likely a return to the ‘normal’ office environment should not be expected in the short term.  What this situation has also created is shadow vacancy where landlords are collecting rental even though the space is not being optimally utilised. In this regard, uncertainty remains on what will constitute a ‘normal’ office environment in the future and what would be the space requirements and its configuration in this new environment.

Source: SAPOA office vacancy report, Catalyst Fund Managers
Data is as at 31 December 2020

The weak office fundamentals were the result of sluggish economic growth, which translated into muted office demand, and significant supply especially in the P grade segment in Sandton. Going forward, the supply situation appears to be much more favourable with only 113k sqm of office space currently under development. As a percentage of existing stock, this equates to c. 0.6% which is the lowest it has been in decades. Supply is likely to remain muted over the short to medium term given the amount of space readily available. We have also seen an increasing willingness to consider alternative uses for vacant office space with residential conversion being the most popular alternative proposed.

Source: Company data, Catalyst Fund Managers
* data as at June 2020, # data as at August 2020

Rental collections in the industrial segment were high during the lockdown period; however, the sector is not immune to the impact of the pandemic on the broader economy. In this regard, we have seen a slight increase in vacancies across all the major listed industrial landlords. It is also important to note that not all industrial in the listed space is new modern facilities as a sizeable portion is still exposed to the traditional manufacturing sectors.

Source: StatsSA, Catalyst Fund Managers
Data is as at 31 October 2020

Source: StatsSA, Catalyst Fund Managers
2020 YTD:  data as at 31 October 2020

The increased investment into e-commerce capabilities and the need to optimise supply chains has led to an increase in logistic space demand both locally and internationally. In this regard, we have seen a noticeable supply response over the last few years with the amount of industrial space being built exceeding the long-term average. For 2020, while the full dataset is not available, it is surprising to note that for the 10 months to October 2020 industrial and warehouse space completed is c. 81% of long-term average despite the havoc in the construction sector because of the pandemic. We expect this demand to continue as retailers adapt to changing consumer demands. Despite the structural demand drivers in this sector, we believe rental growth is likely to remain subdued. This is due to a weak economic backdrop, availability of land for new construction and the lack of building cost inflation over the last few years which is placing a ceiling on market rental levels.

Source: Company data, Catalyst Fund Managers

Collection rates during the hard lockdown period varied across the different sectors with the lowest recorded in the retail segment. Data on collection rates has not been uniform with some companies including arrear payments while others have shown collection rates as a proportion of adjusted billings (after discounts and deferrals). In the above data from Nedbank’s listed client base and Growthpoint (as the largest SA landlord), we see a positive trend in collection rates. This trend has continued and its estimated that collection rates has risen to 97% of total billings (including arrears collections – as per SBG securities).

Source: SBG securities; * indicates interim figures.

Property rentals were under pressure before the advent of Covid-19; however, a large component of the decline in net property income for the year is attributable to rental relief provided to tenants and an increase in expected credit losses. In the above graph, we illustrate the relief provided to tenants as a percentage of their rent. The majority of the relief provided by landlords took the form of discounts and concessions to contractual rentals. This has an immediate impact on earnings as revenue declines without a comparable change in expenses. It should be noted that the percentage is higher for those reporting interim numbers (relief measured as a proportion of 6 months rental as opposed to 12 months). Expected credit losses has also increased as the ramifications of the severe decline in economic activity affects tenant’s ability to meet their obligations.

Source: Bloomberg, Catalyst Fund Managers

The severe economic fallout combined with a subdued inflation outlook led to an unprecedented 300bps cut in the repo rate to 3.5%. This is the lowest it has been since 1998.

The swap curve flattened by 222 bps over the last year, with the 5-year rate now at 4.73%. Majority of the debt in the listed property sector is subject to fixed rates (80%+) and the benefit of lower funding costs is likely to filter through as new facilities and interest rate swaps are negotiated. While the swap curve has flattened significantly, we note that debt margins have increased which will offset some but not all of the lower interest costs benefit.

Source: Bloomberg & Catalyst Fund Managers
Data is as at 31 December 2020

Debt to assets across the sector has increased as direct property valuations have come under pressure. The current debt to total assets is c. 40% which is well above the historical average of 32% but remains below average bank covenant levels of 50%.