Energy challenges, opportunities for property owners and listed property companies

06 April 2023

Over the past couple of years, the listed property sector has withstood quite a few challenges which have caused plenty of volatility in share prices and led to a derating of the sector.

Covid-19 was especially difficult to navigate, but thankfully most of its challenges are now behind us. A huge bump in the road to recovery was the civil unrest of July 2021, along with localised flooding in KwaZulu-Natal in April 2022. The Russia-Ukraine war threw another curveball at global markets, leading to high inflation and an increase in interest rates.

Figure 1: Performance of the FTSE/JSE SA Listed Property Index (2019-2023)

Source: Bloomberg

The sector has shown resilience in the face of these challenges, evidenced by continued recovery in its market capitalisation and the FTSE/ JSE SA Listed Property TR benchmark. However, prices and absolute dividend levels have not yet fully recovered to pre-Covid levels. The big challenge on everyone’s lips now, of course, is load-shedding.

According to the Council for Scientific and Industrial Research, South Africa experienced 3 773 hours (157.2 days) of load-shedding in 2022, a 223% increase over the 1 169 hours of disruption recorded in 2021. The report noted that 2022 was also the first year in which most load-shedding came in at stage four, rather than stage two. December 2022 alone was subject to more load-shedding than any other year.

So far in 2023, this high-intensity load-shedding has continued.

The impact on the economy and the sector is undoubtedly negative. In January 2023, the South African Reserve Bank (SARB) downwardly revised its gross domestic product (GDP) forecast for 2023 to 0.3% and 0.7% for 2024 partly as a result of extensive load-shedding. Listed companies have recently been reporting eye-watering costs related to increasing diesel consumption as they grapple with the energy crisis. The cost of low-sulphur diesel in rands per litre increased by about 35% in 2022.

Figure 2: Cost of low-sulphur diesel per litre

Source: Automobile Association of South Africa

Coupled with higher fuel consumption as load-shedding intensifies, these snowballing costs will lead to some degree of margin contraction or negative impact on profitability.

One sympathises with small- and medium-sized enterprises which cannot afford this financial outlay and do not have the luxury of tapping into alternative power sources. Many will end up on the casualty list of businesses that have been forced to shut their doors. The average person on the street will also bear the brunt, as there will be an attempt to pass on these costs to consumers.

Apart from the financial consequences, the increasing collective reliance on diesel generators will increase carbon emissions as the energy consumption mix shifts away from renewables in the short term. Unfortunately, this will undo some of the progress made in addressing South Africa’s environmental sustainability.

Figure 3: Hourly distribution of load-shedding, January - December 2022

Source: Council for Scientific and Industrial Research

RETAIL BEARS THE BRUNT

In the listed property sector, the largest impact of load-shedding is likely to be felt in the retail sector.

Management teams have indicated that diesel cost recovery rates are around 50%, with non-recovery mostly due to the existence of common areas in shopping centres which are not lettable and therefore generate no revenue. This represents a lower recovery than that of the office and industrial sectors, which achieved higher recovery rates from tenants.

In Hyprop Investments’ recent results presentation for the interim period to 31 December 2022, the company reports that the fund’s average cost of diesel through load-shedding came in at R8.83p/ KWh, compared to the Eskom/local authority cost of R2.44 p/KWh. This high cost is certainly unsustainable.

Apart from the negative margin impact, passing on these costs to tenants will lead to an increase in their occupancy costs in the absence of improving trading revenue. Given current macroeconomic headwinds, the growth in trading revenue within shopping centres will be benign and occupancy costs will inevitably rise. This will likely lead to pressure on rental reversions or negotiated rentals at lease expiry, which could reverse some of the improved metrics recently reported. Rental reversions on retail leases remain negative, although to a lesser extent than in 2020.

On the upside for the retail sector, especially for non-urban centres, load-shedding has increased footprint in some shopping centres since these are some of the few places with sufficient energy to remain operational, at least during trading hours. As consumers turn to shopping centres as a respite from the gloom, centre tenants may be able to entice increased sales.

The impact on the office sector, meanwhile, is positive in the respect that offices are no longer standing half empty as staff stream back to the workplace to avoid load-shedding at home. Most office buildings catering for large corporates have backup power, offering a welcome alternative to homes without electricity. Many companies also now require employees to spend more time at the office.

Although the effects of load-shedding are undesirable, the situation presents an opportunity for the sector to reduce its reliance on the grid and fast-track the use of renewables or green energy. More capital expenditure is being allocated to solar projects that offer property owners attractive yields on cost and will be accretive to their earnings in the medium to long term. There will also be cost savings flowing through to tenants, which will provide some relief related to occupancy costs. Property owners and tenants’ energy mix will shift away from diesel and towards renewables, which is a much more desirable outcome in the long run.