Operating costs hit commercial property sector

ALTHOUGH slowing in pace, operating cost increases continue to have a negative effect on income growth in the commercial property sector.

Operating costs have been driven mainly by administered prices — including electricity, rates and taxes, and municipal charges — which limit the ability of landlords to pass on meaningful rent increases to tenants.

Investment Property Databank (IPD) data show that while operating costs have been rising above inflation mainly due to administered prices, the pace of cost inflation slowed last year.

Grindrod Asset Management chief investment officer Ian Anderson said retail landlords “have it slightly easier” than the office market in terms of negotiating rentals, given administered price growth.

Due to higher vacancies and weaker fundamentals in the office sector, “it is going to become increasingly difficult to push through those increases and the tenants are probably going to push back quite hard”, he said.

Last month, power utility Eskom was refused an application for a 16%-a-year tariff hike for five years, and was granted instead an 8% hike, although this remains above inflation.

Mr Anderson said the lower Eskom increases, which were “now a lot more manageable for the listed property sector”, had been a positive development for the sector.

Neil Stuart-Findlay, portfolio manager at Investec Asset Management, said administered price rises above inflation were a concern for the industry and would “continue to be a feature of results going forward”.

The bottom-line effect for listed property groups varied significantly, depending upon management’s ability to offset this cost inflation through top-line rental growth. Generally, counters with exposure to dominant regional shopping centres continued to trade well with “decent escalations and renewal rates on expiry of rentals”, while the office market was seeing rental reversions when leases needed to be renewed

There was little indication of a significant slowdown in administered price growth in the near term, although lower electricity price increases were “positive”, Mr Stuart-Findlay said.

Some listed property companies were taking action to alleviate the effect of administered price increases and “are making concerted efforts to reduce tenants’ total cost of occupation”. Over the medium to long term, this “reduces the tenant’s total cost of occupation and hence the landlord has more bargaining power when renegotiating rents”.

For example, Growthpoint was focusing on office developments which included measures such as better air-conditioning efficiency and improved natural lighting, while Vunani was making its buildings more energy-efficient, and had achieved “substantial savings” in both electricity and water usage, he said.

Letter from the editor

"Running a business which deals with new leases everyday, its important to note that costs such as electricity are passed onto the tenant by the landlord. Yes, the increased electricity prices will increase the "cost of occupation" for the tenant but this is the same as all of us mere mortals paying extra for our bag of groceries.

However, what I have noticed is the increase in costs have created a stronger barrier to entry for new small businesses. After weighing up the various commercial space options a large percentage of new business's end up running their businesses from their homes. To me, this is a good option until their production warrants a commercial lease. When and if that happens SME's will unfortunately have to absorb those costs and run a leaner machine."

Craig Cooper - Warehouse Finder