Recession expected to have severe impact on tenant payment performance

11th May 2020

By: Simone Liedtke

Creamer Media Social Media Editor & Senior Writer

     

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Financial services provider First National Bank (FNB) expects “a very significant” deterioration in residential rental tenant payment performance for this year, with a recession more severe than that of 2008/9 expected for this year.

While the tenant performance deterioration in response to an economic shock “can be swift”, FNB on May 11 said the full recovery process thereafter could take a lot longer.

FNB also anticipates some average rental through 2020 and 2021, with many residential tenants seeing a decline in incomes or, in certain cases, no income at all.

In a media release, FNB referred to the Covid-19-related lockdowns as an “abnormal” component to the current recession, with “normal” being where economic cyclical pressures – such as the state of the global economy or rising interest rates – periodically drive the domestic economy into recession.

However, FNB believes there is a “very normal component” to the current recession too, which was playing itself out prior to the coronavirus outbreak. South Africa was already in a recession from the second half of 2019 and this will likely play out for a while after domestic lockdowns have ended, FNB noted.

In other words, even as the lockdown is phased out, its aftermath can expected to be felt for some time, as the financially weakened household and business sectors slowly work their way back to improved financial strength, something that can be expected in any significant recession.

Commenting on the impact this would have for residential tenant payment performance, and how long it may last, FNB said it was “tough to answer”, given that predicting the full magnitude of the current recession unfolding was near impossible, much depending on how successfully the Covid-19 pandemic is contained both locally and globally, which will then determine how fast economic life can return to being 100% normal.

However, FNB said there was enough evidence to suggest that South Africa would enter into a deep recession this year, likely significantly more severe than the 1.5% gross domestic product (GDP) contraction of 2009, in what was called the global financial crisis (GFC).

FNB forecasts a 4.5% GDP contraction, while “certain other forecasters are more pessimistic”.

FNB, meanwhile, indicated that “there appears to be a good link between economic performance and residential tenant payment performance, as one would expect, given the economy’s influence on employment and income”.

Taking the 2008/9 recession period as a benchmark, and using tenant performance data, FNB observed that a sharp dip in the percentage of tenants “in good standing” with their landlords coincided with that recession early in 2009.

From about 85% early in 2008, the percentage of tenants in good standing dropped sharply to 71% by the first quarter of 2009, while the percentage that paid on time dropped from 70% early in 2008 to 54% by the end of 2008.

The tenants “in good standing” percentage is significantly higher than the “paid on time” percentage at any time owing to the former number including the group of tenants that received a grace period for payment from their landlords.

“It would therefore appear that the rental market is highly sensitive to economic cycles and sharp shocks.”

Viewing the 2008/9 recession tenant performance dip in a little more detail, FNB noted that the percentage of tenants that “did not pay”, as well as the percentage receiving a grace period from landlords spiked quite sharply around that time.

The grace period percentage increased quite significantly, from 14% of total tenants early in 2008 to 21% of total tenants by the end of that year.

As such, “if a more mild recession”, including a 1.5% yearly dip in 2009 caused the tenants in good standing percentage to bottom at 71% early in 2009, FNB said South Africa “should probably expect a more significant decline in this percentage in 2020, based on the more severe FNB GDP contraction forecast of 4.5%”.

As such, FNB expected the quarterly bottom point to likely be in the between 50% and 60% range, possibly in the second or third quarters of this year.

However, the yearly average percentage may look a little less severe, owing to the first quarter “in good standing” percentage keeping the yearly average up somewhat, with the first quarter not yet seeing much of the major lockdown measures.

The preliminary first-quarter “tenants in good standing” percentage was 78.6%.

Nevertheless, FNB indicated that the yearly average forecast for the percentage of tenants in good standing was still a weak one at 67%, and this was likely to include a very significant rise in the percentage of tenants being given a grace period to get through the lockdown period too.

While it would appear that there is very little time lag between an economic shock and the decline in the percentage of tenants in good standing, FNB noted that “there does seem to be a considerable time lag involved in the tenant recovery process thereafter”.

Examining quarterly year-on-year GDP growth around the 2008/9 period and during the immediate aftermath, FNB said that the GDP rate of year-on-year decline bottomed at 2.58% in the second quarter of 2009, one quarter after the “tenants in good standing” percentage hit rock bottom.

GDP growth then began to benefit from massive global and domestic policy stimulus, recovering to a peak of 3.5% in the first quarter of 2011, nearly two years after the bottom.

But while the GDP post-recession peak was early 2011, the residential tenant population took significantly longer to fight its way back to health, with the post-recession peak in the percentage of tenants in good standing only being achieved at a level of 85.95% in the third quarter of 2013, over two years after the economic growth recovery peak.

Therefore, while the initial performance of the tenant population towards the end of the recession improved quite sharply (from 71% of tenants in good standing in the first quarter of 2009 to 80% by late that year), thereafter the “second phase” of the improvement took another three-and-a-half years to complete.

“This time around, one could probably expect a similar trajectory, with a rapid initial improvement in tenant performance coming late in 2020 assuming lockdowns are ended and many incomes can resume,” FNB commented.

However, it advised that the second stage of the tenant recovery could once again take a few years.

Hence, despite the economy being forecast to return to its stagnant low positive growth rate of between 0% and 1% as from 2021, by 2023 FNB projects the percentage of tenants in good standing to reach as high as 76%, not yet near the last peak above 85% back in 2013, a decade before.

One aspect that could make the tenants “in good standing” number surprise on the upside is the possibility that many landlords are sympathetic to the problem many good tenants face during lockdown, and may be far more accommodating this time around, compared with 2009, in terms of granting grace periods to tenants.

In this period of weakness, FNB also expects to see some average rental deflation in the average rental numbers, and pencilled in -3% for this year and -4% in 2021.

Edited by Chanel de Bruyn
Creamer Media Senior Deputy Editor Online

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