Commercial Property Crunch: How mismanaged Municipalities impact demand and investment

Badly-run municipalities do more than just annoy residents and lead to rubbish pile-ups – they can also be a slippery slope to wide-scale economic decline. For urban centres in particular, the signs of a badly run municipality soon become impossible to ignore, symptomatic of a loss of confidence in the economic viability of the area and fears that crime rates will rise as opportunists capitalise on vacant buildings,

“The stark contrast between Cape Town and Durban’s CBDs illustrate the detrimental impact that inadequate service delivery can have on surrounding commercial real estate businesses,” shares John Jack, CEO of Galetti Corporate Real Estate. “While there is still a significant amount of economic potential in the city, sustained efforts will be needed to restore Durban to a thriving and safe hub for businesses and consumers alike.”

Cape Town remains an outlier.

“Cape Town’s infrastructure has received a significant boost from both private investment and the City of Cape Town itself, with the latter allocating R6.94 billion to infrastructure upgrades during the 2022/2023 fiscal year. The benefits of this significant cash injection are evident in the bustling foot traffic and the low vacancy rates of both office and retail buildings in Cape Town’s CBD,” he adds.

The Q4 2023 FNB Property Broker’s Survey revealed that looking for more reliable utilities and services is now the fourth biggest factor driving owner/occupier sales, with 37,49% of respondents giving this as their reason for moving on. FNB links this to the deterioration of infrastructure and service in various municipalities, compounded by the ongoing energy crisis.

“Cape Town’s municipal efforts to end loadshedding by purchasing electricity generated by independent power producers and less intensive power outage schedule is a major attraction to businesses in other parts of the country considering relocation,” Jack says.

Jack believes that Cape Town is a prime example of the positive impact that private investment can make. “The private sector is intervening and taking back poorly functioning municipalities. Cape Town is a prime example of the benefits of a public private partnership.”  

“We urge municipalities to start encouraging and supporting this. It will help speed up the return of capital to the city, help reduce expenses on the fiscus and return on capital investment which in turn improves the rate of recovery.” Jack adds that “the alternative is that the municipality rallies against the initiatives because they want to retain control in a form of ego battle. If this is the case, then you will see capital flight and a worsening condition.”

Unpacking the fallout: The four major effects of mismanaged municipalities.

He unpacks the four main consequences of badly run municipalities on commercial real estate as follows:

1. Decreased property values.

Property values are influenced by the overall stability of an area and inconsistent service delivery can make commercial landlords uncertain about the future. Thus, the value of property within a poorly run municipality becomes less desirable to both landlords and tenants, impacting demand and decreasing property values. “Lower property values can result in larger economic decline due to a decrease in job opportunities and economic activities within an area, as well as higher crime rates due to fewer economic prospects.”

2. Loss of investor confidence  

Private investment plays just as crucial a role as a well-run municipality in preventing CBDs from becoming ghost towns. However, investor confidence is closely linked to their belief in a municipality’s ability to maintain high levels of service delivery.

“This money is typically allocated towards infrastructure upgrades, which in turn attracts more businesses to the area and further cash injections from investors looking for stable markets,” says Jack.

3. Higher vacancies

“Badly run municipalities can, over time lead to a mass exodus from a certain area due to frustrations over service delivery. Unfortunately, vacancies can often have a domino effect, with businesses following their competitor’s lead and leaving once bustling high streets empty.”

Higher vacancy rates are directly linked to a city’s average capitalisation rate, where higher figures represent higher risk. The Q3 2023 Rode Report found that Durban’s average capitalisation rate for Grade-A decentralised office property was at 11.6%, reflecting a higher level of risk in investing in the city. In contrast, Cape Town’s average capitalisation rate stood at 9.7% - well below the national average of 11.1% and the lowest of any South African city.

4. Landlords must spend more on private services.

Halting operations during a power outage is not an option for most businesses, particularly those in the logistics sector and for those that deal with consumers directly. As a result, ongoing loadshedding has forced many landlords to invest in costly alternative power sources to shield their tenants.

“Loadshedding affects all parts of South Africa, but there are some areas that experience longer periods without power because of damages to substations and wire theft, which the municipality may not attend to in a timely manner. As a result, landlords and businesses in these areas are under increased pressure, with frustrations compounded by other service delivery failures like no refuse removal or water outages,” says Jack.

Landlords taking on the burden of paying for private suppliers to maintain service delivery can have a knock-on effect on raised rental prices for them to remain financially afloat.

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