Are the good times ending for industrial?

Robert McLean

#cee, #proptech, #development a #architecture

Škoda Auto is responsible for 5% of Czech GDP on its own and produces 8% of the country’s total exports. In good times, those are impressive numbers. But if the company’s production is halted, say, because there’s a lack of chips, they become scary numbers. Given the country’s dependence on the Volkswagen subsidiary, Škoda’s warning that it would be shutting down its production lines for a couple of weeks was bad enough. But now we’re hearing predictions that 2021 output could fall by 250,000 vehicles this year. And that the situation could extend into most of the first half of next year.

industrial

100 = share prices of industrial property companies as of April 26

The problem isn’t just the taxes that won’t be collected, and the reduced wages of people working Skoda plants. There’s the universe of suppliers to consider, with their thousands of employees. These come in various sizes and with wildly varied financial reserves. But most of them rent industrial space.

The pandemic has been kind to the industrial property sector, not least because e-commerce boomed beyond everyone’s wildest dreams. But uncertainty over the automobile sector looks certain to take the shine off of proceedings. One way to gauge the mood is to look at the stock market. This graph tracks the share prices of listed European property companies over the last six months, as well as how the FTSE performed over the same period. Industrial shares grew about as robustly as you would have thought. But there could now be signs of a dip. If nothing else, the momentum seems to have been knocked off course.

I asked economist Mark Robinson a couple questions on the matter.

At what point (if at all) would you expect to see supply chain issues stunt growth? Will the market distinguish between industrial portfolios with “endangered” components and those more focused on e-commerce?”

Robinson: We are seeing already in the Czech Republic that supply chain issues are stunting growth. The halting of production at Škoda is a front-and-centre example that might knock 1% off GDP growth. This sort of thing has already been occurring for some time already in other exporting countries, especially in East Asia. What matters for Czechia and these other countries is that exports and manufacturing are so large relative to, say, consumption or government investment. This places the manufacturing portion of the industrial real estate sector in a vulnerable position when thinking about demand. In terms of e-commerce, yes, that will likely be treated separately by investors and be more insulated from any downturn. The only circumstance that I see where it will not be seen as different is if unemployment spikes without a COVID lockdown being involved.

What impact would non-transitory inflation have on industrial portfolios and property companies?

Inflation eats away at the profit margins of industrial suppliers. They can cope if they can pass on costs to customers but Czech producer prices are rising now at a 10% year-on-year rate. That’s a lot for customers (us or European manufacturers / consumers) to absorb. So, the manufacturing tenants are unlikely to be happy to absorb higher rents in the coming quarters because their margins and, increasingly, operations are being squeezed. For portfolios, I think yield compression is coming to an end. Yes, supply is very limited but fast local (CNB) interest rate rises and all of the supply chain and profit margin issues will disturb end demand. We are not at the beginning of an economic cycle here, much more nearer the end. And if inflation persists in Europe as well, the ECB will finally have to raise the cost of capital, meaning the cost of funding will slowly inflate.

 

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