Amid escalating geopolitical tensions and financial volatility, interest rates are rising in response to accelerating inflation. The interest rate in South Korea spiked after a record low of 0.5% in 2020, returning to the 2% range for the first time since October 2014 (2%). In addition, the Bank of Korea (BOK) is forecasting CPI inflation rate of 4.5% in 2022, the highest since reaching 4.7% during the global financial crisis in 2008. What does a rising inflation rate mean for the Korean logistics market?
Figure 1: CPI & Benchmark Interest rate in Korea
Source: Bank of Korea
Rents
Firstly, inflation tends to push rents upwards. In general for logistics leasing contracts, the inflation rate is often a proxy in setting the annual/biennial rental growth. Hence, rent increases are tied to the inflation rate to a large extent. In addition, due to the current boom in e-commerce in Korea, dry centres are boasting healthy market sentiment with low vacancy, which has encouraged landlords to increase rents further. Therefore, logistics centre rents in the Seoul Capital Area (SCA) market are likely to be on the rise for the time being, depending on the inflation rate and vacancy levels.
Figure 2: Construction cost index
Source: Statistics Korea
Supply
A rapid surge in the inflation rate also means a considerable lift in construction costs. As the prices of construction materials, such as cement, ready-mixed concrete and bituminous coal, have risen one after another, construction costs have increased, causing major disruptions to supply plans. According to Statistics Korea, the Construction Cost index rose by about 12% y-o-y in May, representing rising construction costs in all sectors. Developers have been delaying the start of construction as soaring material prices act as major headwinds. A growing number of development projects are behind schedule by more than a quarter.
Investment
The BOK has continued to lift base rates to tame rapidly rising inflation. Such financial volatility impacts all aspects of the logistics market, including NOI, supply volume and cap rates, consequently affecting investor sentiment. While investors/owners have more incentives to increase rents in the face of rising inflation, implied higher financing costs may act as major headwinds. In addition, as construction material costs continue to rise, investors may be keen to acquire assets through forward sales (acquiring assets before completion) to brace for larger cost upticks in construction materials in the near term.
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