CONSENSUS seems to be developing amongst economists that the South African economy is going to decelerate sharply to a growth rate of about 3% p.a. over the next few years. Says Bellville-based property economist Erwin Rode of Rode & Associates: “This is much lower than the 5% p.a. developers have come to expect over the last few years, and it will no doubt lead to a slowdown in the take-up of space, and might result in rising vacancy rates in some areas. There is of course a school of thought that believes that when interest rates decline – as many are predicting may happen early next year – so too will cap rates. This, however, is a fallacy, as the correlation between interest rates and capitalization rates is actually very weak.”

Says Rode: “It is reasonable to assume that vacancies have now reached their best levels and, therefore, we might now see some upside pressure on them. What’s more, rising vacancies could be viewed by investors as posing a risk to the expected cash-flow streams from property, which might induce investors to require higher income returns (capitalization rates) to buy property.”

Evident from the research presented by Rode & Associates, is that capitalization (cap) rates have followed vacancy rates sharply south since 2003, on the back of the vigorous demand for rental space that was brought on by strong economic growth. As a result, vacancy rates since 2003 for prime property in the Cape Town CBD, for example, have dropped from about 16% to 4% currently, while cap rates decreased over the same period from 13% to 9% currently.

Rode notes that interest rates seem to have peaked and may start the downward path soon. “However, before jumping to the conclusion that this would change the outlook for property markedly, we should consider the very likely scenario that interest rates are not going to drop back any time soon to the levels of two years ago.” Reasons quoted by Rode include:

• In the wake of a stalling world economy, softening commodity prices will lead to a deterioration in South Africa’s terms of trade,

• Which will lead to a softening rand (this has already started to happen),

• Which, together with sharply growing Eskom tariffs, will put pressure on inflation (even though it is off a high base),

• Thereby necessitating relatively high interest rates.

Rode concludes: “In any event, with hindsight we now know that interest rates were allowed to drop too low last time around.”