The article was first published on 28 June 2021
Award-winning investment strategist and co-founder of Brenthurst Wealth Management Magnus Heystek puts pen to paper on what he calls nothing short of a calamity – the value destruction that is the South African property market. As always, Magnus’ strong opinions are backed by the facts, with listed and non-listed property feeling pain all over the country despite some respite for parts of the Western Cape. One of South Africa’s best stock pickers, Piet Viljoen, shared a similar sentiment (link attached for ease of reference) to Magnus, calling the ‘buy-to-let’ model a no longer plausible investment. – Justin Rowe-Roberts
One of the more sane voices in the listed property sector, RMH says “it is still grappling with a glut in SA’s property market, which could delay plans to unlock value for shareholders”
— Piet Viljoen (@pietviljoen) June 30, 2021
By Magnus Heystek*
THERE is no other investment area in South Africa which is more exposed to the brutal, wealth-destroying policies of the ANC and its policy of cadre-deployment than the local property market, whether listed or residential, it matters not. Perhaps only the lower-priced residential areas with prices around the R1m-mark showing some kind of resilience – not growth, mind you.
In virtually all other categories in all parts of the country have property owners suffered a massive destruction of wealth which, in my estimation, looks permanent. Property values in most small and medium-sized town in 8 of the country’s provinces have – due to a variety of reasons – evaporated.
It’s only in certain parts the Western Cape where properties have kept values, to a certain extent.
And yet, when you read the commentary about property, especially residential property, from our property marketing companies, you would think the country is in the grips of a full-blown property boom. In fact, it’s not.
And this is at a time when most countries in the developing world are experiencing unprecedented booms in their domestic property markets.
I have seen with my own eyes how formerly pristine towns and cities such as Kimberley, Bloemfontein, Rustenburg and others have collapsed at great speed.
Long before Lichtenburg became from-page news, due to Clover announcing the closure of SA’s largest cheese factory, have I seen and written about this collapse. There are many other Clovers and Lichtenburg’s in the country, but the only reason it was front page news was the fact that Clover is a listed company and was legally obliged to make a formal announcement.
There are many hundreds of “Clovers” around the country where, over the past 10 to 15 years small and medium sized businesses and factories have simply shut up shop or moved somewhere else due to the collapse in local government. And yet, government, who is so fond of talking about smart cities and high speed trains, have either not been aware of this collapse or simply don’t care.
I have witnessed this over the past 5-7 years on my annual cycling trips to the Karoo. But I also have, due to the nature of my profession, picked this up from clients scattered all around the country, all providing first-hand experience of this collapse.
Each and every time I wrote columns about this trend, was met by a barrage of denials, accusations of being “negative and the best of all: “if you don’t like it here, why don’t you f#ck off”.
But it seems as if mainstream media has at long last started to write about the collapse in local government. The Financial Mail published a cover article in March, about the collapse of Johannesburg, SA’s largest city, with the headline ‘A sinking city?”.
Yesterday former Financial Mail editor Peter Bruce wrote the following in his column in the Sunday Times: ”It is truly an incapable state. It can’t fly an airline, deliver a letter, fill a pothole, pick up litter or mow the lawn. It can provide water, oxygen, personal protective equipment or live doctors and nurses to its hospitals. On top of this pile, sits Cyril Ramaphosa.”
And this is a columnist who has generally been very supportive of Ramaphosa and the ANC over many years, urging voters to vote ANC in the previous general election in 2018 to give the ruling party “another chance”.
The fortunes of a property investment, more so than all other asset classes, is dependent on factors such as law and order, good governance and an enabling environment (maintenance and improvement of roads, sewerage and electricity) and the practical application of by-laws. Without these factors in place, properties can lose most if not all of its value.
Unlike other asset classes, property is illiquid, it cannot be moved and very often the property owners can do very little about what goes on outside the front door.
Your property sits there: immovable and powerless and it cannot be moved to another part of the country or even offshore.
Add into this mix a slowing economy – even well before the Covid-19 pandemic – and the rise of Working From Home (WFH) and it’s clear that property investors, either directly or via pension/retirement funds, are facing further pain on this front.
The balance of power in the property market – especially office buildings – has swung decisively from price setters to price takers. Rental adjustments (historically the CPI plus 4) have been turned into rental adjustments of minus 20-40% in some cases, due to Working From Home and vacancy levels up to 35% in some sectors.
Catastrophic loss of value
Some, rather hopeful property analysts (referring to listed properties), often try and “talk up” the market by calling for its bottom, but I would suggest that investors take a closer look at his radio interview on Moneyweb about 2 weeks ago with CEO of Sapoa, Neil Gopal.
It’s clear that Gopal is not seeing any permanent upturn in the listed property space. In fact, he is of the view that further “catastrophic” losses are to be expected, if the trend in runaway rates and taxes cannot somehow be reined in.
Suren Naidoo: Sapoa, or the South African Property Owners Association, is one of the country’s oldest property bodies. Over the years Sapoa has perennially raised the issue of spiralling commercial rates and taxes and its impact on the industry. In this episode we zone into the issue with Sapoa CEO Neil Gopal.
Sapoa has more than 800 members and is the voice of the commercial property industry in South Africa. Hi Neil, welcome to the Property Pod..
Suren Naidoo: Neil, you’ve been at Sapoa for over a decade, so you know this issue well. It’s a hot-button issue for your sector. What I want to know is how serious municipal rates and taxes are, especially in the context of Covid-19.
Neil Gopal: Suren, as you know, we have been at pains for many years, long before Covid-19, trying to highlight the catastrophic value destruction that municipalities are causing with unsustainable above-inflation increases in municipal rates. Just to give you an idea of some of the statistics – we’ve been keeping decades’ worth of stats on particularly administration charges and operational costs – from 2006 to 2019 municipal charges grew faster than any other operating cost.
They [commercial property rates and taxes] quadrupled from R10 in 2006 to R41 as at end-December, 2019.
This is becoming a bigger and bigger and faster-growing property operating cost since 2006. This is also prior to the global financial crisis. On a five-year rolling basis annualised growth and property taxes have exceeded CPI since 2008. As a result, rates and taxes, according to our numbers, have grown by a cumulative 318% over the last 10 years or so, compared to 78% of CPI. So way above CPI.
Suren Naidoo: Those are some crazy numbers you throw out there. When you talk about R41, what are you referring to?
Neil Gopal: Out of every R100 of rental that a landlord would make, close to 50% is going towards operating costs, and a huge chunk of that then goes to property rates. You’ve still got your water cost, you’ve got your electricity costs. The trouble with this is it’s unsustainable, particularly with property rates. The challenge, of course, with the water and electricity, as we’ve experienced, particularly with electricity, is there’s no guaranteed supply of electricity – and those costs are going up by over 25% a year. So it’s a triple-whammy of combined costs, which the property owner has no control over and it’s very difficult to budget for these things.
Suren Naidoo: Neil, we still hear CEOs of listed and private property companies complain about unsustainably high rates and taxes. The likes of Resilient and Growthpoint on the listed side often mention this in their annual results or results presentations. Despite this, service delivery from municipalities is generally poor. So you have really high rates and taxes and you don’t have the commensurate level of service. Maybe you want to wade in here?
Neil Gopal: It’s important to start off with the basis of this matter. Local municipalities, as organs of state, are constitutionally bound to provide services to taxpayers. So that’s the starting point. But what we’ve seen over the years – if you look at the graphs very, very carefully, if you read the auditor-general’s report last year – is that there’s a dire situation out there.
The AG’s report is extremely disturbing. You have 98% of municipalities that are dysfunctional. Only 20% in the country have achieved a clean audit.
There’ve been a spate of court orders forcing services to be placed in the hands of residents, which is unfortunate. We shouldn’t have residents or residents’ associations or businesses running a municipality. This is why we pay rates and taxes.
This speaks to your point of the lack of service delivery. [It] is largely as a result of wasteful and irregular expenditure, corruption in procurement processes, and poor adherence to financial controls. The dire state of our roads, water and electricity services is as a result of poor governance measures. And, of course, we have increased levels of false declarations regarding municipal tenders that play into all of this.
So not a good situation for property owners. We’ve had to establish central improvement districts [CIDs] around the country, to which property owners have to pay a certain amount on a monthly basis; but they also pay their property rates. So a double-whammy for property owners. You are paying property rates and a levy to the CIDs to provide the service that the municipality doesn’t provide.
Suren Naidoo: The CIDs are another story altogether. They are doing some good work across the country in various cities and urban areas. When it comes to specific municipalities or metro cities, which are the worst performers in terms of overcharging, would you say? Are you in a position to maybe highlight some of the bad performers in terms of overcharging?
Neil Gopal: Yes, I can. We ran an interesting exercise a year ago, looking at the property-rates revenue of municipalities, and what the results have shown is that over the last few years there has been an unreasonable and unacceptably excessive increase in revenue from property rates.
So, if you look at some of the budgets, Buffalo City, for example – that’s East London and its surrounds – in the 2018/2019 budget they generated nearly 46% of all of their revenue from property rates.
If you look at a place like the City of Johannesburg, a metro like the City of Johannesburg, in the 2018/19 financial year 37.5% was generated from property rates. Now, in Ekurhuleni you’re looking at nearly 30% during the 2017/2018 financial year. These are staggeringly high figures, and it’s also a bit of a dangerous situation for a municipality to rely so heavily on property rates. The impact of Covid has now kicked in, and properties being devalued is likely to mean that less property rates will be paid. So a challenging time lies ahead for both property owners and municipalities going forward.
Suren Naidoo: On that note, Neil, you’ve kind of moved to my next question. In this environment where commercial property is taking a hit from the Covid-19 financial fallout, we are not really going to see municipalities dropping their rates, are we?
Neil Gopal: Well, we are hoping some of them do. We’ve been in negotiations and discussions throughout the integrated development-planning process with many municipalities. We have formally made submissions to the top 50 municipalities with regard to their rates policies and their budgets.
Some disturbing trends we are noticing are that, even during the middle of Covid, municipalities are budgeting for significant salary increases – double CPI for senior management. It’s unfortunate and an extremely disturbing pattern out there. I think Moneyweb reported that [Mpumalanga’s Steve Tshwete] municipal manager last July, in the middle of Covid, gave himself [I think] a 50% salary increase. So not a nice situation.
But I think if municipalities do want to incentivise businesses, given the impact of Covid, given the fact that a lot of small businesses are shutting down, one way to revive the commercial property sector is to not have any property rates increases. That’s what we’ve pleaded with the municipalities for. But not all of them have come to the party, as you’ve suggested.
Suren Naidoo: It’s a cash crunch. Where do they get the money from, though? You often have complained and, from our discussion now it’s clearly a case of the commercial property sector being the cash cow, the golden goose – and you don’t want to kill the golden goose, as it were.
Neil Gopal: I agree with that, Suren. I think there’s a number of factors that come into play. The municipalities need to understand that you cannot continuously try to squeeze blood out of a rock. I prefer to look at the entire property-rates universe as an iceberg; 90% of the iceberg is under the water and you can’t see it. So I suspect what the municipalities are doing is that they’re going after that little 10% that’s above the water – and it’s easy to nail those guys.
They are listed on the Johannesburg Stock Exchange. They have their annual reports. You can pull up the annual reports. You can see for yourself, as the chief valuer in any city, this is what the value of Sandton City is, for example. But of 90% of the iceberg that’s lying under the water you don’t have any sight. There are no annual reports.
There’s a huge component of the residential sector – if they just get to fix up the property values around that side of the equation, I think it should be a fair and transparent process and everybody should pay their fair bit; but you cannot continuously hammer a small component of the business community to keep you alive and make sure that the municipality keeps its head above water. It’s an unsustainable situation.
Suren Naidoo: From Sapoa’s side, Neil, I know Sapoa advocates for lower hikes, and in some instances on various other issues takes municipalities to court and that sort of thing. But what can Sapoa do, because clearly municipalities are not listening? Are you speaking to the South African Local Government Association, Salga? Are you speaking to Treasury? How can you contribute to these municipalities’ looking at a more sustainable way in terms of getting income?
Neil Gopal: Suren, you mentioned something important – taking municipalities to court. I think that’s the last resort. It’s a lengthy process, it’s an expensive process. It’s not conducive to any relationship-building exercise between the public and private sector. So for us going to court and trying to put out fires around the country at every municipality – where the members have huge assets and are huge contributors to the rates space of a municipality – is not an ideal situation.
We know that the Minister of Cooperative Governance and Traditional Affairs [Cogta], Minister [Nkosazana] Zuma, is empowered in terms of the Municipal Property Rates Act to issue a directive to many of these municipalities, if not to all of them, particularly the ones that are abusing the rates policy, and the directive is that she can impose certain limits on the percentage by which rates and property categories – or a rate on a specific category of properties – may be increased and what that rate is.
We made an approach to the Cogta minister last year [stating that] given that we were hit with Covid, largely the office and the retail sectors and shopping centres were all empty, and yet property owners had to pay their property rates. So we have made an approach to the minister. We hope to have an engagement with her going forward – with her and Minister Tito Mboweni, the minister of finance – to find a solution around this. So yes, they use an advocacy parallel process that has been run in terms of negotiating directly with government.” He said.
Investment case for property
There you have it, no sugar coating and the reality facing property owners and its investors. This flies in the face of regular comments by fund managers operating in this space, who on a regular basis try and make out an investment case for investors to remain invested “throughout the cycle,” as is the commonly used term. I would suggest this is going to be a case of fund managers defending their funds from further outflows.
Almost on the same day newly appointed Auditor-General Tsakani Maluleke spoke at a conference on governance at the Wits University, saying amongst other things, that at many municipalities cannot even put basic financial statements together.
Quoted on News24 she said that year in and year out, the AG finds awful audit outcomes when looking at local government’s financials and it has become clear that they have serious shortcomings in financial management skills. Some would say, there are no skills at all.
Maluleke said her office has noticed that there is no discipline on the part of accounting officers to reconcile these bank accounts and expenditures on a daily, monthly or quarterly basis.
Instead they try and come up with something they can present – in order to comply – to the Ag months after the event.
They then outsource the compilation of their financial statements to private sector accountants, spending around R900m to produce work that government employees ought to do.
In 2020 the AG identified 75 material irregularities to the value of R6.9bn.
Anecdotal evidence suggests that this number is just the tip of the iceberg and that the expression “material irregularities” is a euphemism for blatant theft and corruption.
Even JP Landman, political commentator for Nedbank and related companies, had to deviate from his normally upbeat commentaries, by saying the following in a recent newsletter (June 15 2021:
“It’s by design. In China, for example, mayors and provincial leaders are appointed and promoted from the centre. In SA, local government is completely decentralised and its autonomy as a level of government is protected by the Constitution. This means that local power elites have a lot of leeway, can dispense patronage, appoint family and loyalists and general mismanage things. Power corrupts and absolute power corrupts absolutely.”
Elsewhere he says: “Local government poses a fiscal risk to the SA government. Of the 278 local authorities in SA, 163 are in financial distress and 40 are in serious financial service delivery crisis. In a display of wishful thinking, 102 have adopted budgets they cannot fund.”
The wealth destruction in the listed property sector over the past 5 years has been astronomical. I saw a report which mentions a decline in market capitalisation of the listed property sector from R600bn to around R220bn currently.
The total loss in value of SA’s property stock – listed, unlisted, owned by government and the private sector – must be measured in the trillions of rands.
Another way to measure this decline in value is the collapse of the price in the Liberty Life Property fund – a fund that owns amongst others upmarket buildings such as Sandton City and Eastgate. (See charts and tables).
Compared to the CPI-inflation numbers over 5 years, have investors in this fund – and most certainly all other funds – lost an astronomical 58% decline in consumption power.
For years retired investors put their money into property funds such as these on offer by Liberty, Sanlam and Old Mutual.
And for many decades investors were rewarded with above inflation growth in dividends with capital values rising along very nicely indeed.
But well before Covid-19 could one see the downturn in this sector, brought on by lower economic growth, rising rates and taxes and also over-development. These factors are not going to go away in a hurry and therefore listed property still remains in the doldrums and investors can therefore expect further declines in values.
Retail investors can get out of this asset class but the losses will mainly be hidden in the greater portfolios of the SA’s retirement funds. I spent some time looking at the asset allocation of several of SA’s largest investment funds, and most continued to have an allocation of between 3 and 5% to this sector.
But the total loss of wealth brought about by the collapse of the property sector nationwide as described above must certainly run into the trillion of rands. At best one can only guesstimate the destruction of values over the past 10-15 years.
It will take a far more in-depth analysis by someone like Mike Schussler, consulting economists Brenthurst Wealth, to run the numbers, but it’s my view that the broad collapse in property values in SA across all categories in REAL terms has caused massive financial destruction at a personal level.
A simple exercise will show what I mean. R10 000 invested into a local property fund such as thee Ninety One Property Equity fund 5 years go is worth R6,500 today. The same investment into a global property fund, such as the Ishares Global Real Estate fund will have a value of R12,500 today.
And this happened during a period where rand weakness plays no role as the ZAR/USD exchange rate is virtually unchanged. The offshore investor has almost 100% more purchasing power than the local investor! And that over just 5 years.
- Magnus Heystek is investment strategist at Brenthurst Wealth. Voted Top Boutique Wealth Manager in 2017 and 2020.
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