Quiet apocalypse of office property

An unexpected consequence of Covid-19 was that many of us worked from home, with almost as many wondering why we hadn’t done this before.

Why hadn’t we? We had the technology, we had the means. What we were lacking was the business buy-in. Lockdowns forced this, and in many instances it worked fine.

Going on three years later, a consequence of this is that around a quarter of Sandton office properties are now standing vacant. This is not unique to SA. It reflects all around the world, from London to New York.

Read:

In fact, if we look to Kastle’s Back to Work Barometre (a US-based weekly occupancy report from a supply of access systems to offices), it recovered steadily to around 50% and then flatlined. It is currently at 48.5%.

Source: Kastle Back To Work Barometre – Weekly Occupancy Report, 10 April 2023

While a 48.5% occupancy makes Sandton look good, this is not comparing like with like.

Kastle’s data tracks employees coming into the office (clocking in via access control) while Sandton’s vacancies can be seen by tracking unleased, empty offices.

Either way, employees not using an office is a pretty good leading indicator towards businesses eventually cancelling office leases.

Which is a leading indicator pointing to a quiet apocalypse in the office property market …

No dramatic announcements yet

All of our local listed real estate investment trusts (Reits) that have office space begrudgingly acknowledge the pressures – but if we are honest, there have been no dramatic write-downs, impairments or declarations of this stress financially.

I am not picking on Redefine Properties (RDF), but rather using it as an example.

By looking at a large, local Reit that was traditionally heavily weighted in the office space, and using the nice data sets it provides, we can work out the following:

• Pre-pandemic in FY19, Redefine had 1.2 million metres of gross lettable area (GLA) that had a vacancy rate of 13% and a valuation of R21.17/m^2;
• Post-pandemic in FY22, Redefine has shed nearly a 10th of this space, yet its vacancy rate has risen to 14.5% (it will sell the ‘bad’ property before the ‘good’);
• Redefine’s valuation of its remaining property is only 6.8% lower than FY19’s level (R19.81/m²).

The following charts show Redefine dumping its office properties, yet vacancies lapping it and valuation per square metre remains relatively flat (actually being written up in FY22):

Source: Redefine

Even if Redefine’s office portfolio was better quality than the rest of the world’s, surely the valuation of this property would track (at least) the inverse of vacancies rising 1.5% (from 13% to 14.5%)?

Yet interest rates (a key factor in valuing yielding property) are materially higher today than they were in the 2019 period (see here), which implies that – even if fundamentals had stayed the same as pre-pandemic – valuations should be under pressure.

Read:

Again, I am not picking on Redefine, but using it as an example.

Most of those in the JSE-listed Reit sector that own offices look similar to some degree or another:

Office valuations have barely budged yet employees keep not going back to the office.

Which will lead to office leases not being renewed and/or office space being shrunk.

Which will (eventually) have to lead to a drop in office valuations across the listed Reit sector on the JSE …

And everyone is wondering why so many of our listed Reits are trading below book value. Well, sometimes book value is not actually book value.