Tougher year for retail property in 2019

by JOHN LOOS

While the emergence of online shopping as a retail alternative deserves to be taken seriously by the retail property sector, the state of the economy and household sector finance remain arguably the biggest near term sources of pressure.

The South African Reserve Bank (SARB) March Quarterly Bulletin completed the 2018 picture for the consumer, and it did not make for good reading.

The recent economic growth weakness dampened real household disposable income growth, taking it down to a meagre 0.6% year on year in the final quarter of 2018, from 1% in the prior quarter. This continues a recent slowing growth trend from a relative high of 3.7% year on year as at the third quarter of 2017.

What is also a concern is that nominal household disposable income growth has weakened to slow rates last seen around 2009 at the time of the financial crisis, and the only thing keeping real disposable income growth slightly positive is a very low inflation environment, itself a reflection of a weak economic environment.

Using the Private Consumption Expenditure Deflator (PCE) to measure consumer inflation, the rate was a lowly 4.3% year on year in the final quarter of 2018, a sign of very low supplier pricing power.

And the SARB Leading Indicator for January showed a further fall, suggesting the near term outlook for the economy and disposable income growth could be still weaker.

On a year on year basis, the leading indicator fell by a significant -3.4%, while on a month on month basis it declined by -1.8%. This represents a speeding up in the pace of decline from prior months.

Also exerting pressure in disposable income growth, beside the weak economy, is a constantly rising effective personal income tax rates as government finance deteriorates. For most of the time, government raises personal taxes through not fully adjusting for bracket creep caused by wage inflation. Personal and wealth tax amounted to 15.6% of household sector income in 2018, up from the 15.3% of 2017 and now almost 5 percentage points above the 10.8% of 2004.

The 2019 Budget looks set to bring about a more significant increase in this percentage, given that there was not even partial bracket creep tax bracket adjustment this year.

Also noticeable in the household sector income data was further slowing in wage bill growth, the most reliable and largest source of household sector income.

From a post-financial crisis high of 11.7% in 2010, wage remuneration growth has slowed all the way to 4.2% by 2018, a marked deceleration from 7.4% just a year before in 2017.

The far more erratic net income from property, which is the SARB’s term for net income from investments in general, spiked to 24.5% growth in 2018, but it is difficult to see this source of income sustaining such growth in such a weak economic environment.

The near term looks set to be a period of even greater pressure on household consumption spend and retail sales growth.

Not only is the leading business cycle indicator in decline, but certain more consumer-related leading indicators are also under pressure.

Real household consumption expenditure growth had slowed to 1.1% year on year by the fourth quarter of 2018.

The component of consumer spend whose growth is most cyclical, and often leads the direction of overall consumer spend growth, is the durable goods consumption category. This category, too, has slowed significantly to 1.1% year on year, from a high of 9.2% back in the 1st quarter of 2018.

Then, moving into early-2019, we examine one high frequency durable goods sales number with a strong consumer link, that is NAAMSA new passenger vehicle sales growth. In January and February, this indicator saw sharp year on year declines of -11% and -13.5% for the two respective months, which can be a leading indicator of further weakening in durable goods consumption growth, and then overall consumption expenditure growth, to come.

In this weak income growth environment, there are also limits to how far households can take their borrowing for housing and consumption purposes.

Indeed, we have seen the household sector attempting to boost its spending growth through a mildly faster rate of borrowing.

At 6.9% year on year the rate of household sector credit growth is elevated from the 3.3% multi-year low recorded in the fourth quarter of 2016. However, its pace of growth has already surpassed the lowly 4.9% rate in nominal disposable income growth, and this means that even at a fairly modest rate of borrowing growth the household sector debt-to-disposable income ratio has begun to rise, from a 71.3 low at the end of 2017 to a 72.7 ratio at the end of 2018.

This, along with a lone interest rate hike in the fourth quarter, takes the debt-service ratio slightly higher.

The single-most important macro-predictor of the level of household sector credit stress is arguably the household debt-service ratio. This ratio reflects the cost of servicing the household sector debt, interest only, expressed as a ratio of household sector disposable income. Its drivers are thus the value of household sector debt, the value of household sector disposable income, and the average level of interest rates on household sector debt.

The debt-service ratio rose slightly in the fourth quarter of 2018 to 9.3, from 9.1 in the prior quarter, on the back of a slight rise in the debt-to-disposable income ratio as well as a 25 basis point interest rate hike.

The most recent 9.2 debt-service ratio level is mildly elevated from its early-2013 decade-low of 8.5. This mildly elevated ratio may have started to cause increased financial stress, as seen in a deterioration (increase) in insolvencies levels of late, with the 803 insolvencies recorded in the final quarter of 2018 being the highest level since the third quarter of 2014, and sharply higher than the 652 of the previous quarter.

We have for some time been expecting a noticeable increase in the dismal rate of household savings, something that is long overdue but which would be a retail sales negative while in play.

Indeed, the net savings rate (gross savings less depreciation on fixed assets) has improved moderately, from a low of -2.5% of disposable income (net dis-savings) at a stage of 2013 to -0.5% by the final quarter of 2018, having treaded water in recent quarters.

Net saving refers to gross saving net of depreciation on fixed assets owned by households. A net dis-savings rate means that what gross savings takes place is still insufficient to cover all depreciation.

A savings rate improvement is typically what we would expect to see during tougher economic times. The household sector become less confident of the economic future in such times, and by implication of its own future financial situation. It then starts to make greater provision for financial shocks by becoming more conservative in its spending habits.

Such an expected savings response would also appear justified if one examines household sector net wealth trends. At 357.5% of disposable income the household sector’s net wealth has declined from 391.3% as at the first quarter of 2015.

And in the fourth quarter of 2018, its growth in value went negative to the tune of -1.6% year on year, the first quarterly year on year decline since the second quarter of 2009.

Net wealth under pressure could help to spur greater financial conservatism, as households attempt to make up for a lack of asset value growth through higher savings.

We expect the result of a lengthy period of weak consumer confidence to be a deliberate move by the household sector towards more conservative spending and borrowing habits. By “deliberate”, we mean moves over and above merely curbing consumer spend in line with slowing disposable income growth. We mean moves to curb spending growth over and above that, which would translate into a rise in the household sector savings rate.

Indeed, it would appear that the savings rate did improve mildly through 2014 to 2017, even if for the time being this has only meant less of a net dis-savings rate. However, looking ahead, with little sign of the economic weakness ending any time soon, we would expect ongoing weakness in consumer confidence to translate into a rise in net savings back into positive territory (meaning that gross savings levels would once again be enough to cover estimated depreciation on fixed assets owned by the household sector).

In line with the theme of a shift towards greater conservatism by the household sector in 2019, we would also expect a return to decline in the all-important household sector debt-to-disposable income ratio, as household borrowing growth slows once more.

While expected improving savings and indebtedness trends would be welcomed in the longer term, they can add an extra negative to retail sales and economic growth in the short term over and above the already lengthy list of economic negatives.

Early signs are that 2019 looks to be stacking up to be a tougher year for retail and retail property than 2018, just looking at consumer financial fundamentals.

John Loos is the property sector strategist at FNB Commercial Property Finance.