Hefty rate hikes: How commercial properties are valued in SA

Two methods are used to calculate commercial property rates in South Africa. Picture: Valery Anatolievich/Pexels

Two methods are used to calculate commercial property rates in South Africa. Picture: Valery Anatolievich/Pexels

Published Aug 29, 2023


Commercial property owners across the country are bearing the brunt of unsustainable rate increases which, in turn, are negatively impacting South Africa’s economic growth.

Property owners are facing a barrage of financial challenges as a result of the economic environment, load shedding, and the triple whammy of rates that have been going up significantly each year.

Over the past five years, commercial and industrial property owners have objected to rate increases that range from 43 percent to 500 percent, with the average provincial rate increase per province at 20 percent this year, says Mark Govender, a certified property valuer at Swindon Property.

Increases in municipal property valuations and rates have therefore resulted in substantial tariffs being levied on commercial and industrial property owners.

The South African Property Owners Association has raised concerns over the level of rate hikes for this year, and also stated that municipalities are going against National Treasury guidelines by increasing rates by more than 10 percent in recent years. Water and property rates increased by 140 percent between 2010 and 2021, almost double the rise in inflation.

Should attempts to have rates capped failed, the Association has not ruled out taking the issue to court.

Treasury has defended local municipalities though, saying that it was critical for municipal sustainability to adequately recover what it cost to deliver municipal services while also facilitating the maintenance of existing infrastructure and investing in the future growth of the municipal area.

This means that the overall revenue requirement must recover the actual cost of the municipality with a reasonable rate of return.

Govender, however, says these ongoing, hefty rate increases for commercial property “simply make no sense”.

“Not only are they unsustainable, but property owners pass these increases through to tenants, which has a material impact on the health of businesses in the economy.”

How commercial properties are valued

Property valuers conduct a valuation of commercial and industrial properties based on a number of factors. These, he explains, include:

  • 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.

Two of the most common methods for valuing commercial and industrial property are based on the ‘Comparable Sales’ and the ‘Income Method’.

Values based on the comparable sales approach

This 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, Govender explains.

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
  • 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

The Income approach to valuing a commercial property – also called the CAP (capitalisation) rate method of valuation – is arguably the most accurate way to value a commercial property, and is typically the preferred way for banks and property valuers.

“This method of valuation uses a property’s annualised net rental divided by a capitalisation rate to give the value of a commercial building.”

He says the annualised net rental is the gross monthly rental of a property less the property’s operating expenses x (times) 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.

“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.”

One way to think about the cap rate, Govender says, 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.”

This example is very simple in its application though, he notes, as there are 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
  • 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.”

IOL Business