Property Capitalisation Rates - how low can they go?

Various factors have contributed to property being the investment of choice over the last few years.

Initially, residential property was the preferred choice, now it has swung to commercial, with large amounts of funds flowing into a market that has matured, albeit off a low base, and set a good foundation for the future.

This is according to property investment experts, Tony Bales and Guy De la Porte of Bales Delaporte, a niche property investment broking company based in Cape Town.

But the question is, how low can property capitalization rates go?

According to Bales Delaporte, if you were asked three years ago to purchase a retail property yielding 8,5% per annum, you would have thought that someone was taking a big chance. "Today, should there be a good retail centre available for sale, there would be in excess of 20 purchasers eager to drop what they are doing and actively pursue such a transaction."

"The Rode Report 2003:2 states that a regional centre in Gauteng would have attracted a cap rate of 11,9%. The latest edition of the same report 2006:1 states a current cap rate for the same property at 8,5%. This is a 40% increase in value alone, excluding rental growth."

Where does that leave property investors wanting to make an informed investment decision into the future?

"Investing is not without its risks, warns Bales Delaporte. "South Africa is now part of the global 'fish bowl', where funds can generally flow freely into whatever investment avenue appears appropriate at that point in time, and thankfully, the SA commercial property market has been the beneficial recipient of funds wanting a safe haven."

Optimists compare SA property yields to those of USA, Europe and Australia, which in many cases are as low as 3,5% for prime retail centres. "There has been talk of international funds being prepared to possibly even pay a yield of 4,5% for a prime asset such as the V & A Waterfront."

According to Bales Delaporte, in 2004 and 2005 capital inflows into South Africa increased dramatically due to developing market optimism and dollar weakness. How much longer can this situation last, and what will happen when the tide turns the other way?

"Economists have forecast an all-round optimistic picture for the next year or so with interest rates appearing to be at the bottom of their cycle and should start moving upwards shortly."

Bales Delaporte believe that cap rates are likely at their trough, along with the interest rates and that investors should sell investments in a profit-taking manner. "Hedge against interest rate risks with appropriate strategies and become a value related property investor - do not look to buy into the property market just because it is doing well."

Signs that the above is starting to materialize are borne out by the fact that Zenprop have recently sold a portion of their portfolio. "Zenprop are regarded by many as leaders as far as their strategies are concerned. Growthpoint have also openly stated that they are having difficulty finding reasonable investments and have started to focus on refurbishing their existing portfolio as this will yield better results," says Bales Delaporte. "Investors should also not ignore the correction seen on the stock markets during the last week which has resulted in a 6% decline in listed property stocks."

"The old adage of 'even a turkey can fly in a hurricane' has seen many people become successful yet inexperienced property investment experts over the last two years. The next two years are certainly going to be a lot more challenging when seeking out property investment performance in the commercial sector as cap rates will not continue falling," concludes Bales Delaporte.

Article by: