research Capitalisation & DiscountRate Report compiled by IPD

research Capitalisation & DiscountRate Report compiled by IPD

key findings research: Valuation metrics have shown some improvement for the six months ended November 2014, in line with a slightly firmer long bond yield. At the end of November, the All Property discount rate was recorded at 14.6% - the best level since the global financial crisis. It should be noted though, that the aggregate discount rate was pulled down by lower rates in some secondary office markets. These are coming off a high base the majority of property sub-segments actually saw discount rates increase over the last 6 months. The aggregate cap rate continues to trend down on the back of heightened transaction activity. Encouragingly, operating cost and rental growth assumptions are starting to look increasingly favourable. Since the first quarter of 2010, the long bond yield has increased by 140bps while the discount rate has strengthened by 40bps in this period. While this would suggest that a correction in the discount rate could be expected the current interest up-cycle is predicted to be a moderate one given subdued economic growth prospects and concerns over structural issues such as electricity supply & labour market absorption. The current valuation trend is likely to lead to an increased emphasis on factors that have the potential to offset value declines such as higher retention rates, longer leases and strong compound net income growth. The largest increase in discount rates over the last 6 months was in the Warehousing segment where the average discount rate increased by 50bps one percent to above 15%. Large discount rate increases were also reported for most retail segments where the prospect of further slowing in consumer spending and stagnant employment growth are likely to prove a drag on retail rental growth. Surprisingly, the Office sector continues to record lower cap rates, perhaps indicative of the demand coming out of the listed sector. However, there has been an uptick in office sector discount rates which could indicate the perceived risk stemming from current double figure vacancy rates that have essentially been moving sideways since mid-2011. Valuers assumptions around perpetual income and cost growth have shown positive change in the last 6 months 1

Valuation metrics have shown some improvement for the six months ended November 2014, in line with a slightly firmer long bond yield. The South African Reserve Bank (SARB) did increase the prime interest rate by 25bps during this period but are unlikely to aggressively hike rates while inflation remains in their target band of 3-6%. Figure 1 illustrates the recent trend in selected valuation metrics as measured by the SAPOA Cap & Discount Rate Survey. At the end of November, the All Property discount rate was recorded at 14.6% - the best level since the global financial crisis and signals a 100bp compression since a peak of 15.6% was reached at the height of the recession. It should be noted though, that the aggregate discount rate was pulled down by lower rates in some secondary office markets. These are coming off a high base the majority of property sub-segments actually saw discount rates increase over the last 6 months. The aggregate cap rate continues to trend down on the back of heightened transaction activity especially in the listed property sector where low interest rates and favourable cost of capital are making yield-enhancing transactions easier to achieve. This is also reflected in the cap rate/exit cap rate differential which has narrowed significantly since the recession. Encouragingly, operating cost and rental growth assumptions are starting to look increasingly favourable. The gap between perpetual operating cost and income assumptions is currently less than 2% - down from 3.5% post the initial Eskom electricity price increases. figure 1: Long term trend Valuation metrics Q1 2008 Q4 2014 2

Figure 2 illustrates this downward trend in the discount rate since 2010 and the recent dislocation from the bond yield. Since the first quarter of 2010, the long bond yield has increased by 140bps while the discount rate has strengthened by 40bps in this period. figure 2: Dislocation between discount rate and risk free rate While this would suggest that a correction in the discount rate could be expected the current interest up-cycle is predicted to be a moderate one given subdued economic growth prospects and concerns over structural issues such as electricity supply & labour market absorption. Market consensus suggests the SARB is likely to keep rates pegged at the current level at least until mid-2015 - especially if inflation remains inside the target range of 3-6%. This scenario is becoming increasingly likely given downward pressure on oil and food prices on the back of OPEC countries agreeing not to cut the supply of crude oil. Although there is currently a certain level of mispricing between the cap rate and long bond yield it is not significantly out of line with long term trends (Figure 3). The current cap rate/long bond differential is however similar to 1996-1997 which signalled a correction in capital values despite a strengthening long bond yield up to 2002. figure 3: Cap rate and long bond yield (1995 2014) While the current perceived mispricing in the market isn t necessarily going to lead to a correction of the same magnitude as in the early 2000 s or in 2008, it is something to be aware of as we enter an interest rate up-cycle and places an increased emphasis on factors that have the potential to offset value declines such as higher retention rates, longer leases and strong compound net income growth. 3

What is noticeable about the latest survey results is that valuers have adjusted cap and exit cap rates downwards this after adjusting assumptions upwards for the six months ended May 2014 (Figure 4). Normally, this would suggest a more favourable view of medium to long term risk and a simultaneous downward adjustment of the discount rate. However, discount rates were adjusted upwards by 25-50bps across most property types which suggests that cap rates are currently driven by transaction activity rather than property fundamentals. The largest increase in discount rates over the last 6 months was in the Warehousing segment where the average discount rate increased by 50bps one percent to above 15%. Large discount rate increases were also reported for most retail segments where the prospect of further slowing in consumer spending and stagnant employment growth are likely to prove a drag on retail rental growth. The highest discount rate nationally was recorded for low grade industrial property a reflection of valuers bearish outlook for the manufacturing sector which is currently under strain as a result of recent industrial action as well as a weaker currency. Surprisingly, the Office sector continues to record lower cap rates, perhaps indicative of the demand coming out of the listed sector. However, there has been an uptick in office sector discount rates which could indicate the perceived risk stemming from current double figure vacancy rates that have essentially been moving sideways since mid-2011. figure 4: Discount rates adjusted upwards 4

Valuers assumptions around perpetual income and cost growth have shown positive change in the last 6 months (Figure 5). The only property type recording a higher perpetual operating cost assumption is retail centres larger than 25,000sqm where a combination of aboveinflation electricity price and rates increases are weighing on net income growth prospects. The largest decline in assumed rental growth over the last 6 months was seen in the industrial property segments where concerns over electricity supply and a weaker currency could be weighing on valuers minds. A fair amount of transaction activity was observed in retail centres smaller than 25,000sqm and secondary offices- indicative of the current phase of the listed property cycle. Some of the smaller listed funds are striving to achieve their mandate of aggressive market cap growth against a backdrop of low interest rates and a favourable environment for capital raising. Given the shortage of quality stock and related yield compression at the top end of market, these segments currently offer greater opportunity for yield-enhancing acquisitions. Over the past 6 months, transactions were fairly evenly split across the three main property sectors. figure 5: Retail & Industrial income expectations adjusted upwards 5

Market Discount Rate Property Type MIN MAX MED AVE Retail Office Industrial Super Regional Shopping Centre >100,000m2 12.00% 13.75% 12.38% 12.63% Regional Shopping Centre: 50-100,000m2 12.30% 15.00% 13.13% 13.34% Small Regional Centre: 25-50,000m2 13.00% 15.00% 13.50% 13.80% Community Shopping Centre: 12-25,000m2 12.80% 15.30% 14.25% 14.26% Neighbourhood Shopping Centre: 5-12,000m2 13.75% 15.80% 14.50% 14.66% Local Convenience Centre < 5000m2 13.75% 16.00% 14.50% 14.70% Power Centre/Speciality/Warehouse 14.25% 15.50% 14.50% 14.69% Stand Alone Retail Unit 14.00% 15.50% 14.50% 14.65% Johannesburg CBD Office 14.00% 18.50% 15.00% 15.79% Non CBD Prime Office 14.00% 16.00% 14.25% 14.53% Non CBD Secondary Office 14.50% 17.50% 15.50% 15.67% Pretoria CBD Office 14.00% 16.50% 15.00% 15.13% Non CBD Prime Office 14.00% 15.50% 14.25% 14.44% Non CBD Secondary Office 14.50% 16.50% 15.00% 15.20% Cape Town CBD Office 14.00% 15.00% 14.50% 14.47% Non CBD Prime Office 13.30% 15.00% 13.88% 14.09% Non CBD Secondary Office 14.75% 16.50% 15.08% 15.35% Durban CBD Office 14.50% 15.50% 15.25% 15.13% Non CBD Prime Office 13.50% 14.50% 14.00% 14.00% Non CBD Secondary Office 14.50% 15.50% 15.00% 15.04% Port Elizabeth CBD Office 14.80% 15.50% 15.15% 15.15% Non CBD Prime Office 14.00% 15.00% 14.00% 14.33% Non CBD Secondary Office 15.00% 15.50% 15.25% 15.25% East London CBD Office 17.50% 17.50% 17.50% 17.50% Non CBD Prime Office 14.50% 14.50% 14.50% 14.50% Non CBD Secondary Office 16.00% 16.00% 16.00% 16.00% Other CBD Office 15.50% 16.00% 15.50% 15.67% Non CBD Prime Office 14.27% 15.50% 14.75% 14.82% Non CBD Secondary Office 14.50% 15.75% 15.33% 15.23% High-Tech Industrial 13.80% 16.50% 14.00% 14.69% High Grade Industrial 13.00% 16.50% 14.00% 14.64% Low Grade Industrial 14.00% 17.75% 15.25% 15.72% Warehousing 14.00% 17.50% 15.00% 15.34% Standard Units 14.00% 16.75% 15.00% 15.28% Other 15.00% 17.00% 15.83% 15.92% 6

Market Cap Rate Property Type MIN MAX MED AVE Retail Office Industrial Super Regional Shopping Centre >100,000m2 6.25% 9.00% 6.63% 6.96% Regional Shopping Centre: 50-100,000m2 6.75% 9.50% 7.00% 7.54% Small Regional Centre: 25-50,000m2 6.75% 10.50% 7.50% 8.07% Community Shopping Centre: 12-25,000m2 6.80% 10.00% 8.38% 8.50% Neighbourhood Shopping Centre: 5-12,000m2 8.00% 10.50% 8.50% 8.94% Local Convenience Centre < 5000m2 8.00% 11.00% 8.88% 9.00% Power Centre/Speciality/Warehouse 8.00% 11.00% 8.75% 8.88% Stand Alone Retail Unit 8.00% 11.00% 9.00% 9.25% Johannesburg CBD Office 10.00% 11.50% 10.75% 10.82% Non CBD Prime Office 7.75% 10.00% 9.25% 9.05% Non CBD Secondary Office 8.50% 12.00% 10.50% 10.25% Pretoria CBD Office 8.70% 11.50% 10.63% 10.49% Non CBD Prime Office 8.61% 11.00% 9.50% 9.55% Non CBD Secondary Office 9.30% 11.00% 10.75% 10.55% Cape Town CBD Office 8.50% 10.00% 9.00% 9.20% Non CBD Prime Office 7.75% 10.50% 8.75% 8.82% Non CBD Secondary Office 8.50% 10.50% 9.65% 9.55% Durban CBD Office 10.50% 11.00% 10.50% 10.63% Non CBD Prime Office 8.00% 9.75% 8.63% 8.88% Non CBD Secondary Office 8.50% 11.00% 10.25% 9.94% Port Elizabeth CBD Office 11.00% 11.00% 11.00% 11.00% Non CBD Prime Office 8.50% 10.00% 9.50% 9.38% Non CBD Secondary Office 9.30% 11.00% 10.50% 10.27% East London CBD Office 12.00% 12.00% 12.00% 12.00% Non CBD Prime Office 8.61% 11.00% 9.81% 9.81% Non CBD Secondary Office 9.30% 9.30% 9.30% 9.30% Other CBD Office 11.00% 11.50% 11.00% 11.17% Non CBD Prime Office 8.61% 11.00% 10.25% 10.03% Non CBD Secondary Office 9.30% 11.50% 10.75% 10.58% High-Tech Industrial 8.00% 11.20% 9.25% 9.28% High Grade Industrial 8.00% 11.00% 9.50% 9.50% Low Grade Industrial 9.00% 12.50% 10.75% 10.66% Warehousing 8.30% 12.00% 10.00% 10.03% Standard Units 8.50% 11.50% 10.00% 9.95% Other 9.56% 13.00% 10.25% 10.77% 7

Market Rental Growth Rate Property Type MIN MAX MED AVE Retail Office Industrial Super Regional Shopping Centre >100,000m2 5.00% 7.00% 6.25% 6.13% Regional Shopping Centre: 50-100,000m2 5.00% 7.00% 5.64% 6.03% Small Regional Centre: 25-50,000m2 5.00% 8.00% 6.42% 6.39% Community Shopping Centre: 12-25,000m2 5.00% 8.00% 7.00% 6.44% Neighbourhood Shopping Centre: 5-12,000m2 5.50% 7.00% 6.45% 6.32% Local Convenience Centre < 5000m2 5.50% 7.00% 7.00% 6.40% Power Centre/Speciality/Warehouse 5.17% 7.00% 6.00% 6.13% Stand Alone Retail Unit 5.00% 8.00% 6.25% 6.31% Johannesburg CBD Office 4.00% 7.00% 5.00% 5.64% Non CBD Prime Office 4.00% 8.00% 5.50% 5.93% Non CBD Secondary Office 4.00% 7.00% 5.39% 5.66% Pretoria CBD Office 4.00% 7.00% 5.50% 5.57% Non CBD Prime Office 4.00% 8.00% 5.50% 5.85% Non CBD Secondary Office 4.50% 7.00% 5.39% 5.71% Cape Town CBD Office 4.00% 6.50% 5.50% 5.38% Non CBD Prime Office 4.00% 8.00% 5.48% 5.80% Non CBD Secondary Office 5.00% 6.50% 5.79% 5.76% Durban CBD Office 5.00% 6.00% 5.00% 5.25% Non CBD Prime Office 5.00% 6.00% 5.50% 5.50% Non CBD Secondary Office 5.00% 6.00% 5.00% 5.36% Port Elizabeth CBD Office 5.50% 5.50% 5.50% 5.50% Non CBD Prime Office 4.00% 6.00% 5.48% 5.16% Non CBD Secondary Office 5.79% 6.00% 5.89% 5.89% East London CBD Office 5.50% 5.50% 5.50% 5.50% Non CBD Prime Office 5.48% 5.48% 5.48% 5.48% Non CBD Secondary Office 5.79% 5.79% 5.79% 5.79% Other CBD Office 4.50% 5.00% 5.00% 4.83% Non CBD Prime Office 4.50% 5.48% 5.00% 4.99% Non CBD Secondary Office 4.50% 5.79% 5.00% 5.07% High-Tech Industrial 4.50% 7.00% 6.00% 5.93% High Grade Industrial 4.50% 7.00% 5.75% 6.00% Low Grade Industrial 4.00% 7.00% 5.00% 5.50% Warehousing 4.00% 7.00% 6.00% 5.86% Standard Units 4.00% 8.00% 5.75% 6.00% Other 5.00% 7.00% 5.44% 5.81% 8

Property Expenditure Growth Property Type MIN MAX MED AVE Retail Office Industrial Super Regional Shopping Centre >100,000m2 6.00% 10.00% 7.75% 7.88% Regional Shopping Centre: 50-100,000m2 6.00% 10.00% 7.86% 7.92% Small Regional Centre: 25-50,000m2 6.00% 10.00% 7.88% 8.17% Community Shopping Centre: 12-25,000m2 6.00% 10.00% 8.00% 8.17% Neighbourhood Shopping Centre: 5-12,000m2 6.00% 10.00% 7.75% 7.82% Local Convenience Centre < 5000m2 6.00% 10.00% 8.00% 7.95% Power Centre/Speciality/Warehouse 6.00% 10.00% 8.00% 7.68% Stand Alone Retail Unit 6.00% 10.00% 8.00% 7.93% Johannesburg CBD Office 6.00% 10.00% 8.00% 7.86% Non CBD Prime Office 6.00% 10.00% 7.50% 7.67% Non CBD Secondary Office 6.00% 10.00% 7.66% 7.82% Pretoria CBD Office 6.00% 10.00% 7.50% 7.82% Non CBD Prime Office 6.00% 10.00% 7.00% 7.62% Non CBD Secondary Office 7.00% 10.00% 7.66% 8.10% Cape Town CBD Office 6.00% 8.50% 7.25% 7.25% Non CBD Prime Office 6.00% 9.00% 7.00% 7.42% Non CBD Secondary Office 7.00% 8.50% 7.33% 7.61% Durban CBD Office 7.00% 8.50% 7.25% 7.50% Non CBD Prime Office 6.86% 8.50% 7.00% 7.37% Non CBD Secondary Office 7.00% 8.25% 7.33% 7.42% Port Elizabeth CBD Office 7.00% 7.00% 7.00% 7.00% Non CBD Prime Office 6.00% 6.86% 6.43% 6.43% Non CBD Secondary Office 7.33% 7.33% 7.33% 7.33% East London CBD Office 7.00% 7.00% 7.00% 7.00% Non CBD Prime Office 6.86% 6.86% 6.86% 6.86% Non CBD Secondary Office 7.33% 7.33% 7.33% 7.33% Other CBD Office 7.00% 8.75% 7.00% 7.58% Non CBD Prime Office 6.86% 8.50% 7.00% 7.34% Non CBD Secondary Office 7.00% 8.50% 7.16% 7.46% High-Tech Industrial 6.00% 8.25% 8.00% 7.46% High Grade Industrial 5.00% 8.25% 8.00% 7.41% Low Grade Industrial 6.00% 8.25% 7.50% 7.39% Warehousing 6.00% 8.50% 8.00% 7.50% Standard Units 6.00% 8.50% 7.50% 7.43% Other 7.46% 8.25% 8.00% 7.90% 9

Exit Cap Rate Property Type MIN MAX MED AVE Retail Office Industrial Super Regional Shopping Centre >100,000m2 7.25% 10.00% 8.00% 8.42% Regional Shopping Centre: 50-100,000m2 6.50% 10.50% 7.50% 8.14% Small Regional Centre: 25-50,000m2 7.00% 11.00% 8.63% 8.95% Community Shopping Centre: 12-25,000m2 8.00% 11.00% 9.50% 9.51% Neighbourhood Shopping Centre: 5-12,000m2 9.00% 11.50% 9.51% 9.75% Local Convenience Centre < 5000m2 9.00% 12.00% 9.75% 10.15% Power Centre/Speciality/Warehouse 9.00% 12.00% 10.25% 10.24% Stand Alone Retail Unit 9.00% 12.00% 10.21% 10.32% Johannesburg CBD Office 10.00% 12.00% 11.75% 11.46% Non CBD Prime Office 8.54% 10.75% 9.75% 9.69% Non CBD Secondary Office 9.39% 12.00% 11.00% 10.86% Pretoria CBD Office 10.00% 12.00% 11.50% 11.09% Non CBD Prime Office 8.54% 10.50% 10.00% 9.72% Non CBD Secondary Office 9.39% 11.50% 11.25% 10.90% Cape Town CBD Office 8.60% 11.00% 9.75% 9.78% Non CBD Prime Office 8.54% 10.50% 10.00% 9.71% Non CBD Secondary Office 9.39% 12.00% 11.00% 10.80% Durban CBD Office 11.00% 12.00% 11.00% 11.25% Non CBD Prime Office 8.54% 11.75% 9.25% 9.61% Non CBD Secondary Office 9.39% 12.25% 10.75% 10.78% Port Elizabeth CBD Office 11.50% 11.50% 11.50% 11.50% Non CBD Prime Office 8.54% 10.00% 9.27% 9.27% Non CBD Secondary Office 9.39% 9.39% 9.39% 9.39% East London CBD Office 12.50% 12.50% 12.50% 12.50% Non CBD Prime Office 8.54% 8.54% 8.54% 8.54% Non CBD Secondary Office 9.39% 9.39% 9.39% 9.39% Other CBD Office 11.50% 12.25% 12.00% 11.92% Non CBD Prime Office 8.54% 11.75% 11.00% 10.57% Non CBD Secondary Office 9.39% 12.25% 11.50% 11.16% High-Tech Industrial 9.73% 10.75% 9.88% 10.08% High Grade Industrial 9.38% 11.00% 10.00% 10.16% Low Grade Industrial 10.32% 12.00% 11.38% 11.30% Warehousing 10.00% 11.50% 10.38% 10.55% Standard Units 9.63% 11.75% 10.25% 10.48% Other 9.56% 11.75% 10.50% 10.60% 10

Number of Transactions Property Type TOTAL Retail Office Industrial Super Regional Shopping Centre >100,000m2 1 Regional Shopping Centre: 50-100,000m2 1 Small Regional Centre: 25-50,000m2 2 Community Shopping Centre: 12-25,000m2 3 Neighbourhood Shopping Centre: 5-12,000m2 3 Local Convenience Centre < 5000m2 3 Power Centre/Speciality/Warehouse 4 Stand Alone Retail Unit 4 Johannesburg CBD Office 4 Non CBD Prime Office 9 Non CBD Secondary Office 12 Pretoria CBD Office Non CBD Prime Office Non CBD Secondary Office 2 Cape Town CBD Office Non CBD Prime Office Non CBD Secondary Office Durban CBD Office Non CBD Prime Office 2 Non CBD Secondary Office Port Elizabeth CBD Office Non CBD Prime Office Non CBD Secondary Office 1 East London CBD Office Non CBD Prime Office Non CBD Secondary Office Other CBD Office Non CBD Prime Office 1 Non CBD Secondary Office High-Tech Industrial 5 High Grade Industrial 6 Low Grade Industrial 5 Warehousing 4 Standard Units 6 Other 2 11

Statistics were provided by the following member companies: property valuation AS V ASSET VALUATION SERVICES C.C. Ian Mitchell Investment Property Consultant Chartered Surveyors & Valuers 12