SIMON BROWN: I’m chatting now with John Loos, property sector strategist at FNB Commercial Property. John, I appreciate the early morning time as always. You put out a note looking at the retail space and comparing it in a sense to the global great financial crisis – that of course in 2008 and 2009. You make the point that [with] the current surge in inflation, the interest-rate hiking cycle, it’s rough out there for consumers but nowhere near, perhaps, as severe as what we were seeing back in the great financial crisis.
JOHN LOOS: Yes, that’s right, Simon. In the global financial crisis everybody got obsessed with Lehman Brothers’ collapse and financial events like that. But what they didn’t realise is that, in my view, the key driving force of the end of the housing bubble in that year or those years was a big inflation surge, very similar to the one now, a big oil-price shock, and a big food-price shock, to the extent that we got to double-digit consumer price inflation.
Up went interest rates by 500 basis points in the process. That was quite a considerable shock and that was what really brought the house of cards … down in the housing market. The retail property market and the commercial property sector in general felt it as well. This time round the surge is less severe to date – 7.8% CPI and petrol prices starting to come off.
So it looks like we might be near the peak of CPI inflation and interest rates up 200 basis points and possibly another hundred or so to go. So not too bad.
But the big difference now is that the run-up to this inflation spike has been far worse than the global financial crisis.
Before that we had economic boom times, which boosted the financial strength of a lot of businesses. This time around we’ve had a big recession in 2020, almost a decade of economic growth stagnation. So we are financially probably a lot more frail and able to take a lot less. That’s the big difference now.
SIMON BROWN: I take that point, absolutely. I remember that lead-up to the rate turn. I remember then-finance minister Trevor Manuel cutting taxes, personal taxes, which was frankly unheard of and hasn’t been heard of since. The other change – you make the point in your note – [is] that the costs and particularly municipal utility tariffs have also been really coming in and putting the squeeze in. So that’s a double squeeze in the sense of, frankly, a lack of economic growth and then a cost squeeze.
JOHN LOOS: Absolutely. The big cost increases, which are the key drivers of operating costs in the commercial property space [are] electricity tariffs, the other utilities’ tariffs and municipal rates. The big hiking started sort of around about the global financial crisis or after that. Up until then we had very cheap electricity. From there onwards [there have been] … most years – above-inflation increases in these items.
So the operating cost environment for especially retail property, for instance, has changed dramatically over the past just over a decade from what it was back then. That’s a key challenge at the moment.
SIMON BROWN: … Retail is undoubtedly tough. It depends on the space you’re in. But retail is a tough space to operate in. Are we seeing an increase in delinquencies? I’m thinking rental payments are behind and that gives an indication of just how bad that squeeze is?
JOHN LOOS: Yes. So what we’ve seen in the TPN data is [that] prior to the global financial crisis there was already a gradual squeeze … but the percentage of retail tenants in good standing was generally above 70%. Now we’ve got back to about 63%. We took a big dip in 2020, down into the fifties, but the percentage of tenants in good standing has clawed its way back, but only as far as about 63%. And early this year it started to show signs of deterioration again.
So it has been [what] I call a ‘partial’ recovery. We haven’t got back to healthier 2019 pre-Covid levels yet, and already the interest-rate hiking from [the TPN] data looked like it was starting to exert pressure yet again.
SIMON BROWN: You mentioned the [interest] rates – maybe another a hundred points or so to the upside. We are seeing inflation coming down a bit. We are seeing, for example, petrol coming down tomorrow, giving some relief to the consumer. Is the consumer going to be in a strong enough place to go out and sort of support retail, or is it going to be another bleak maybe even couple of years for the retail space?
JOHN LOOS: I think it’s a tough year, not bleak, but it’s a tough few years. Look, it’s a lot better than during the lockdown of 2020, obviously, but a hard few years, I think. As I just mentioned, the ‘tenants in good standing’ percentages are not even back to pre-Covid levels yet, so tough years.
And we’ve seen real net operating income of retail – when you adjust for inflation – has been in broad decline since about 2016, as have real capital values when you adjust for inflation too. So it’s been a sort of stagnating environment even before Covid.
And I think that that mediocre environment [will] kind of continue in the coming years, until such time as we hopefully have more meaningful economic structural reforms and get an economy that’s growing at 3% or 4% yet again. But that’s probably somewhere off.
SIMON BROWN: Yeah, it’s that proper economic growth coming in. Of course later today we’ll get our second-quarter GDP.
John Loos, property sector strategist at FNB Commercial Property, I appreciate the early morning time.
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