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“The recent inflation and…

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“The recent inflation and interest rate surge doesn’t appear as severe for retailers and retail property as the 2008/9 Global Financial Crisis one. But the build-up in the preceding years suggests that the retail property class entered current inflation/interest rate surge on a weaker footing,” says John Loos, Property Sector Strategist at FNB Commercial Property Finance.

Recent developments in the area of inflation and interest rates have in many ways resembled the environment leading us into the Global Financial Crisis (GFC). The current environment isn’t as bad as the Global Financial Crisis, but Retail Property has other pressures currently that differ significantly from the GFC period.

The 2008/9 recession in South Africa during the period known as the Global Financial Crisis (GFC) was very much influenced by the same 3 drivers as the present. Around that time, it was a major global oil price shock Brent Crude touching $150/barrel in 2008, accompanied by a global food price inflation shock, and some rand weakness into the bargain.

The result was South African consumer price inflation peaking at 10.7 in the 3rd quarter of 2008, up dramatically from 1.4% in the final quarter of 2006, using a PCE (Private Consumption Expenditure) Deflator measure of inflation. The result of that inflation surge was a 500 basis point interest rate hiking cycle, from 10.5% Prime Rate near mid-2005 to 15.5% by mid-2008.

The GFC retail property impact

The result of that inflation and interest rate surge back around the GFC, along with a global recessionary impact from a similar shock to the rest of the world, was a sharp slowdown in domestic economic growth, and with it a slump in real household disposable income growth in 2008/9.

From strong 5.4% in 2007, real gross domestic product (GDP) slowed to bottom at a negative -1.5% in 2009 before rebounding. The result was Real Household Disposable Income growth slowing sharply too, and Real Consumer Expenditure following suit from a strongly positive 6.5% in 2007 to a negative -2.6% low in 2009.

And, as could be expected, retail property felt it, with real net operating income on retail property (using MSCI data and adjusted for general inflation using a GDP deflator) declining by -18.9% from 2008 to 2010, before recovering thereafter.

Retail property bad debt write-offs as a percentage of gross income receivable went from 0.4% in 2007 to 1% in 2009, according to MSCI data.

This time around appears less severe….or does it?

While the recent consumer inflation surge and interest rate hiking cycle don’t appear as yet to be nearly as severe as the one leading us into the GFC recession, the big difference between now and back then has been the build up to each one.

Whereas the GFC was preceded by a few years of above 5% economic and real household disposable income growth, the current period has been preceded by almost a decade of economic growth stagnation, and then a 2020 lockdown contraction of major proportions.

Even in 2019, the year prior to lockdowns, the economy only managed a slight 0.1% positive growth rate, while real household consumption expenditure managed a slightly stronger 1.1%. Then came the big 2020 dip, real consumption expenditure dropping by -6.5%, and the 2021 rebound not yet even bringing it back to the 2019 level.

This translates into a far more pressured financial environment for consumer, retail tenant and retail landlord alike than the strong growth years preceding the GFC. And there is indeed evidence that consumer confidence is far weaker this time around. In 2008, the weakest level that the FNB-BER Consumer Confidence Index dropped to was a negative -6 reading. As at the 2nd quarter of 2022, the reading was a far more negative -25, a renewed weakening after a muted recovery following the 2020 lockdown dip.

A further major difference between now and the GFC period is retail property operating costs. Very big municipal and utilities tariff increases have been introduced in the period since the GFC, these being a major contributor to the rise in Gross Operating Cost/Gross Income Receivable percentage. This percentage was 30.7% in 2007 prior to the GFC. Just prior to the recent inflation and interest rate hiking surge this time around, this percentage was a significantly higher 42%.

All round retail property affordability in the years building up to the current rate hiking period was significantly worse than prior to the GFC (i.e., more expensive than back prior to the GFC) too.

As at 2015, the all-time recorded high point for real (inflation adjusted) retail property net operating income, as well as capital values, were significantly higher than prior to the GFC, and in a weak economic environment both have already been declining in recent years.

Finally, although we don’t have TPN tenant data that goes back to pre-GFC days, we do know that even with some recovery, at 62% of total retail tenants in good standing early in 2022, the tenant population’s rental payment performance remains significantly weaker than the pre-Covid 19 levels that were above 70%, according to TPN data. The retail tenant population has thus entered the current interest rate hiking cycle in a weak financial state after the Covid-19 knock, it would appear.

Conclusion

The recent inflation surge has been driven largely by the 2 same variables that largely drove the GFC period’s inflation surge, namely oil and food price inflation surges. The result this time around again has been upward pressure on interest rates globally and locally, and resultant pressure on the economy and thus the consumer and retailer.

To date, the most recent rise in inflation and interest rates doesn’t look set to be as severe as the GFC period, that included a double-digit inflation peak and 500 basis points’ worth of interest rate hikes, compared with the recent 200 basis points to date and a further 125 basis points anticipated as inflation looks to be near its peak.

But the conditions during the build up to the current events have been far worse this time around than was the case pre-GFC. As such, we entered this rate hiking cycle likely with a financially weaker consumer, tenant and landlord population than what we entered the GFC with.

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Alan Straton

Chief Cook, Bottle Washer and Broom Mechanic at MyPE
Passionate about Port Elizabeth and definitely NOT packing for Perth. Alan's ethos is epitomised in the words of Nelson Mandela; "I have fought against white domination and I have fought against black domination. I have cherished the idea of a democratic and free society. If need be, it is an ideal for which I am prepared to die." See more articles by Alan.