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State Owned Enterprises – unravelling the government’s property challenges

As the government grapples with funding shortfalls among the behemoth South African state owned enterprises (SOEs), the Ministry of Finance has been looking to sources away from the collection of tax revenues to shore up some gaping holes in the finances of the likes of Eskom. In last week’s budget the then-finance minister Malusi Gigaba suggested that the answer might lie in turnaround programmes supported by equity investments funded through the potential sale of inefficient or underutilised real estate. At the finance ministry’s estimates, the government could potentially tap a portfolio of some 195,000 buildings worth an estimated R40 billion. What are the challenges of this approach and what is the potential implication are for the real estate industry?

February 28, 2018

First, these numbers sound impressive, but the proportion that the government can tap is likely to be far smaller. For some context, the total volumes of commercial real estate transacted in South Africa last year was slightly over R13 billion – roughly a third of that impressive R40 billion that Gigaba mentioned. However, only a fraction of those assets can be disposed of. Understanding how many that might be is virtually impossible without a lengthy review process which seems a huge and unlikely undertaking in any near-term timeframe.

However, the US experience provides some guidance. In 2010 it was estimated that the US Federal Government owned some 900,000 buildings, of which some 2% were in a position that made them candidates for disposal. Applying a similar metric to South Africa would imply a potential pot of about R622 million which is roughly 5% of last year’s total commercial real estate transaction volumes. Spread across numerous poor quality assets, this is hardly an attractive proposition.

Second, should these assets ever come for sale, the market would make the assumption that government is selling the worst of the worst. That is to say, those assets which are too expensive to be redeveloped, cannot be rezoned or where the required capital expenditure is too high to make holding on to them economically justified. At the very least, the market would rightly assume that the government is a forced seller. It is highly likely that the government’s current estimations of value are overcooked.

Third, even assuming these sales could go ahead, as is almost always the case, the government would be selling into a market at the wrong time in the cycle.  For a start, though we think 2018 will be better than 2017, sentiment is at its weakest level in a long time. Real estate investment fell sharply from R28.7 billion in 2016. In addition, there is a heavy pipeline of projects coming to the market in the near future. According to SAPOA, the current pipeline for offices is estimated at some 690,000 m2. Weak volumes and growing supply creates a major challenge for disposals of lower quality stock.

Finally, South African real estate investors continue to diversify away from traditional asset classes and geographies; moving into student accommodation, healthcare and the residential space, as well as continuing their focus in Europe. While not impossible, selling non-prime assets into the current market would require a pragmatic approach to pricing that the SOEs may not be willing or able to take.

Rather, in our view, it would make more sense for the government to focus on a long-term solution to the funding issues with the SOEs rather than a quick fix through selling out assets in a challenging market. In this regard, it is highly encouraging the president Ramaphosa has moved Malusi Gigaba back into the Department of Home Affairs and that the Ministry of Finance is led again by the competent Nhlanhla Nene. Furthermore, that activities of the SOEs are now overseen by Pravin Gordhan as Minister of Public Enterprises would also assuage doubts that the government is looking for a quick fix.

An approach that takes a long-term view by removing the cronyism and inefficiencies that sit within the SOEs would help fix the sector’s credibility issues and at least give a fighting chance of tapping global capital markets when the time comes to refinance. It may well be the case that a review of the government’s property holdings is a timely and sensible strategy to improve internal efficiencies and support cash-flows within the SOEs. However, it is a tactic that should not be a knee jerk reaction to mismanagement, rather a long term measured approach.

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