Commercial and industrial property owners across the country are bearing the brunt of unsustainable rates increases, which in turn, is negatively impacting South Africa’s economic growth, says Mark Govender who is based in Cape Town, and a member of Swindon Property’s national team of certified valuers.
Govender says: “Increases in municipal property valuations and rates have resulted in substantial tariffs being levied on commercial and industrial property owners, which have continued increasing significantly each year. For the past five-year period, these commercial and industrial property owners have raised objections regarding total rates increases ranging between 43% and a whopping 500%. In 2023, while the increases vary per province, they have seen rates increase on average by ±20%.
“Just recently we have seen the South African Property Owners Association (SAPOA) raise further concerns regarding municipalities that are contravening National Treasury guidelines when raising rates excessively, thereby exerting upward pressure on inflation.
“These ongoing, hefty rates increases for commercial property simply make no sense. Not only is it unsustainable, but property owners pass these increases through to tenants, which has a material impact on the health of businesses in the economy.
“While the deadline for objections regarding the recent round of municipal property valuations has passed, the unsatisfactory status quo underscores the importance of property owners using a professional valuer registered with the South African Council for the Property Valuers Profession (SACPVP). It was recently highlighted by the SA Institute of Valuers that unless you are registered with the SACPVP, you cannot undertake any property valuations as you would be contravening the Property Valuers Profession Act and the Property Practitioners Act.”
Govender points out that it is important to note that property valuers conduct a valuation of commercial and industrial properties based on a whole host of factors, including reviewing comparable sales, locality, market rentals, operating costs, tenancy, contractual rentals including the term, vacancies and capitalisation rates for the area in which the property being valued is located.
Elaborating further, Govender says that two of the most common methods for valuing commercial and industrial property are based on the Comparable Sales and the Income Method.
Value based on the Market Approach
Govender explains: “This valuation method is called the Sales Comparison Approach or the Comparable Market Approach and is considered the simplest method to determine the value of a commercial property. This type of method compares the property in question to other properties of similar use and size, which have been sold or placed on the market in the surrounding area. A range of value is established from the findings of the market research, and from there, the number is adjusted, based on the physical characteristics of the property being valued.
“Factors that will likely be considered along with this are discrepancies in the dates of the sale, age and condition of the property, square meters of the actual building and size of surrounding land on the erf, location, land-to-building ratio, local tax policies, and other physical characteristics based on the importance they hold in the current market and the effect they have on the particular property being valued. Basically, this number is determined by what a purchaser is likely willing to pay in an open, fair, and competitive market at that time. A potential buyer may place a less or greater personal value on a property based on how it serves their needs and that of their business, but this is an easy way to determine a baseline to begin negotiations between two parties.
Value based on the property’s Income Method
“The Income approach to valuing a commercial property is arguably the most accurate way to value a commercial property and is typically the preferred way that banks and property valuers will use to calculate a commercial property’s value. It is also called the CAP (capitalisation) rate method of valuation. This method of valuation uses a property’s annualised net rental divided by a capitalisation rate to give the value of a commercial building.”
The annualised net rental is the gross monthly rental of a property less the property’s operating expenses x 12 months. The gross monthly rental is the base monthly rent + parking rent + storage rent + any recoveries charged to a tenant, while operating expenses refer to rates and taxes, operating costs, insurance and maintenance costs.
Govender adds: “The CAP rate is the net operating income of the property divided by its current market value – or sales price. Each area where a commercial property is located will have its own cap rate typically calculated by valuers based on previous sales in the area. So what is the cap rate actually telling you? One way to think about the cap rate is that it represents the percentage return an investor would receive on an all-cash purchase. In other words, if the property is purchased for cash the cap rate would represent a percentage of the annual income of the property.
“For example, take a gross monthly rental of R130 000, subtract the R30 000 operating expenses of the property, to get a net monthly rental of R100 000. Multiply this by 12 months to calculate the annualised net rental, then divide this by the cap rate of say 10%, and you will arrive at a market value of R12 million.”
Govender says: “Obviously, this example is very simple in its application and there are a host of other factors that need to be taken into account when doing valuations based on this method. These include: vacancy rates for an area, whether your tenant is paying market-related rentals versus lower or higher contract rentals, the strength of the tenant, the economic lookout for the environment in which you operate, and future maintenance obligations on the property. Cap rates typically form trends in an area and it is useful to compare cap rates for different areas before making an investment decision.”