The past few years have not been the most encouraging for the South African economy, with anaemic economic growth putting a dampener on business and investor confidence whilst political instability only serves to make matters worse.
Of course, the office market has not been immune to the economic climate and both investors and occupiers have had a challenging time. Rental growth rates in Waterfall have slowed and the office vacancy rate has increased to 12.3% in Q1 2017, a sturdy increase from 11.3% in Q4 2014 around the time when Waterfall opened one of its first offices.
It is within this climate that the market has seen an ongoing increase in new developments which has made investors somewhat nervous. Johannesburg’s office development pipeline now sits at an estimated 793,700m2, a 7.5% increase in overall stock once these buildings come into completion over the next 2-3 years. Competition in the market is getting tighter and the gradual increase in vacancies correlates with the gradual increase in accommodation over the past two years as new completions have been added to the market.
What gives investors the confidence to continue to break ground?
There is that classic argument of the property business cycle: that investors should build ahead of an economic upturn in order to be well-positioned to take advantage of an economic boom when it happens. However, there have been factors that have worked against an economic recovery in SA contributing to GDP growth below 1% in 2016 and a similar figure expected in 2017. Looking at economic forecasts and our local business sentiment measures, it seems the economy is far from a recovery and the market is anticipating a period of stagnation. As a driver of office demand, employment growth is also not very promising at just 0.3% y/y in 2016.
Be that as it may, offices continue to mushroom in Johannesburg, Durban and Cape Town, but more so in Johannesburg. Why? Could it be that in reality things in the market are not as bad as they may seem? Although employment in the Gauteng as a whole only increased by 0.4% in 2016, slightly higher than the national average, the City of Johannesburg actually recorded a much more encouraging 2.3%. This was largely driven by the financial and Business Services Sector, a major office occupier, which saw a 2.4% y/y increase in employment nationally and an encouraging 7.8% y/y in Gauteng alone. The sector in Gauteng province recorded a notable 81,000 increase in jobs in one year.
However, this is not to say that the sector is not under pressure. In fact, with improving office and business efficiencies the growth in office demand is no longer directly proportional to the growth in employment. Rather it is likely to increase at a decelerating rate to relevant employment growth. By way of example, the amount of accommodation required per head has declined with the increasing popularity of open plan office and hot-desks. This has come to play an important role in what occupiers look for in accommodation and what differentiates one asset from another.
It goes without saying that the best quality assets are likely to outperform the market. Although most nodes have seen increased vacancies, overall Grade P stock continues to maintain low vacancy rates at just 2.7% across the city. Waterfall entered the market with non-speculative offices for key tenants. Rental rates were low in comparison to Sandton at R180/m 2. Today Waterfall compares to well-established nodes such as Rosebank and Fourways, in some cases having higher asking rentals. Speculative developments have been well received with the node maintaining low vacancy rates.
What has driven the success of the node in a rather unfavourable climate?
In the prevailing economic climate, even occupiers who are prioritising quality and are keen on a move, are likely to be cost-sensitive. Improved efficiency justifies relocation expenditure. There are three factors which allow for greater efficiency in the Waterfall node that notably improve its attractiveness to occupiers.
First is the promotion of its locational advantage. Waterfall does not add anything significantly new in comparison to the nodes of Sunninghill and Woodmead which are in close proximity to the new business estate. The difference is that Waterfall has harnessed the advantage of the road networks in close proximity, providing centrality between Sandton, Centurion and Pretoria and the West Rand. This attribute, particularly attractive to the logistics enterprise, has allowed some businesses to consolidate warehousing and office space in the same location without producing a node that feels like an industrial area. Tenants such as Colgate have also been attracted to Waterfall due to the larger, younger and varied skills-pull within the radius, drawing talent from the northern, eastern and western suburbs – all with similar distances to Waterfall.
On softer issues, Waterfall presents itself as a place where employees would like to work. A key feature of Waterfall Business Estate lies in its urban design which provides a ’live, work and play’ environment that is gradually taking form as individuals who either live or work in the precinct make greater use of its facilities, including walking tails and bicycle lanes which are not found in other business districts.
Second is the increased consolidation of business operations. Several occupiers have either combined their office and logistics operations into one location as indicated above, or consolidated multiple offices which were in different locations or buildings into one building. This is an important cost-saving element for occupiers which allows them to look at one, centralised corporate real estate transaction. The relatively larger size of the deal also give tenants some level of power in negotiation.
Lastly, is the commitment to both high-tech and Green facilities. Initially a heavy capital expenditure, green-buildings offer long-term cost benefits whilst also contributing to corporate responsibility. Corporates are placing a high priority on “going-green” and the use of technology, innovation and green features hold definite appeal for occupiers. More than a green building, Waterfall can be viewed as a “Green-Node” which may add to its locational advantages in time, setting it apart from other nodes.
In summary, the Johannesburg office environment is best described as a “tenant driven” market at the moment as landlords are competing for occupiers. Recent employment figures parallel to a rise in office vacancies suggest that even when demand recovers, it is not likely to have the same effect on office demand as it would have had in the past. Developers therefore need to be conscious of the changed mind-set of occupiers and the Waterfall Precinct remains a prime example of this.