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How inflation is going to change your world

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Chancellor Rishi Sunak’s spring statement was an effort to cope with an unprecedented cost of living crisis. There are dangers for logistics and warehousing, though nobody agrees how big.

We all know the problem, but does anyone know the solution?

Rishi Sunak faces a threat no Chancellor of the Exchequer has seriously faced since Sir Geoffrey Howe in the early 1980s. That problem is inflation.

It is literally a generation since anyone in the business world had to get to grips with what inflation means for their future. It will take time to learn. But the basic story of what’s coming up is pretty simple: the economy will slow to a gummy, high-cost, low-growth standstill.

If it gets seriously stuck, it turns into stagflation – a toxic combination of very high prices and stable but low economic growth. Stagflation did enormous damage in the 1970s and nobody in their right mind wants to see it return.

The effect on logistics would follow from seriously reduced consumer demand for more or less everything. Workflows will slow, supply chains narrow, overheads will have to be carried despite lower volumes, and if you have lots of expensive staff and top price warehousing this could be uncomfortable. Wages will rise, and so (perhaps) will rents, at a time when your turnover may be falling.

You could, of course, let some staff go and cut your floorspace, but if you did and the economy picked up, could you easily get them back again? If you’re not prepared to take that gamble then there’s no alternative but to suffer a big fall in income but a rise in overheads, and hope it all works out.

Today things aren’t quite that bad, but they could be. The Office for Budget Responsibility, writing in the wake of the Chancellor’s statement on 23rd March, predicted a sharp rise in inflation and an equally sharp fall in economic growth. To connoisseurs of economic disaster, this smells like the prelude to stagflation.

For the record, the current OBR prediction for inflation is that it will peak at a 40-year high of 8.7% at the end of this year, roughly twice their original projection. Economic growth will fall, the analysts reckon, from 6% to 3.8% this year.

Just in case you had a smidgen of hope that the OBR were playing fast and lose, and that it couldn’t be that bad, remind yourself that they are updating predictions made as recently as October 2021. This is not ancient history; it is a fast-moving car crash thanks to the Russia-Ukraine war and a pre-existing combination of supply chain bottlenecks and inflationary pressures.

“With inflation outpacing growth in nominal earnings and net taxes due to rise in April, real livings standards are set to fall by 2.2 per cent in 2022-23 – their largest financial year fall on record – and not recover their pre-pandemic level until 2024-25,” the OBR concluded.

This is all bad news. Wage costs will rise, consumer spending fall, it’s going to be grim.

So two questions arise. First, how long with this last? Second, what does it mean for logistics operators who want – or have just signed up for – new warehousing?

The answer to the first question is that most analysts suggest the pain will be short-lived.

Walter Boettcher is chief economist with surveyors Colliers. His view is that the high inflation/low growth risk period is barely more than a year.

“This inflationary spike is short-term. We need to get through this year, and by the end of 2023 it should be falling,” says Boettcher. “Remember we’re seeing high inflation now because we saw such severe deflation in early 2021 during the Delta wave of COVID infections. That means inflation pretty much had to go up this year as the global economic recovered. But by late 2023 those comparisons will be out of the system and inflation will be falling.”

The Office for Budget Responsivity agrees. Inflation will peak late this year, spend 2023 falling steeply, and be back to the trend-rate of 2% by the start of 2024.

So far, so good. Now for the second question, how will this affect those who want, or already have, new warehouse floor space?

There are two answers. One says things will change, other says they mostly won’t.

First, inflation pushes up the costs of building. That in turn feeds into how viable it is to build in the first place, and exerts a pressure on other parts of the development equation. It means developers may be more reluctant to pay higher land costs if it squeezes their profit too much.

The up-side is that land price growth might slow, and that in turn slow rental growth.

On the other hand, rents – like other prices – can be expected to rise. Even if the logistics sector is squeezed other types of industrial property occupier could be doing alright, so landlords will not feel under immediate pressure to cut rents to keep tenants. If XYZ Logistics plc can’t pay, and leaves their tenancy, then maybe ABC Manufacturing plc will replace them – landlords will be thinking like this.

And besides, good locations don’t stop being good locations just because of inflation. James Goode, director at Avison Young, says: “We expect to see rents to continue to grow, especially in prime locations close to motorway junctions, with good labour pools etc., as tier one occupiers who can justify paying a higher rent for those locations take space.”

This isn’t how others see it. James Salmon is an associate in the West End office of surveyors Allsop. He thinks rents will either stop growing, or take a dip.

“The first impact of rising inflation will be on rents. I just can’t see it not having an impact,” he says. “Sometime in the next six months developers and landlords will have to reign-in their expectations on rents.”

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“How can warehouse occupiers continue to pay more when fuel prices are rising fast. If your average HGV takes 1,500 litres to fill then that’s £2,000 a tank, and that’s going to be the big factor. Everyone’s margins will be cut. They won’t be willing to pay rent increases in the way they were in 2021.”

Salmon thinks the squeeze on economic growth will also slow the sheds market because it will change the way investors – who provide the up-front cash for warehouse development – think about taking risks.

“I’ve been wondering if the market was at the top anyway – yields are as low as they can go – and we may see them plateau. Investors will be more cautious when they appraise schemes,” he says.

The outcome, though, need not be bad news for warehouse occupiers: investors may decide that it makes more sense (because it makes more money) to build new warehouses than to buy existing buildings.

Developers – the people who have to weigh up these conflicting pressures – tend to the more optimistic view. It’s been a brilliant two or three years for anyone with a stake in warehouse property, and they see no reason why the party should end now.

Mike Forster is head of UK logistics development for U.S. property giant Trammell Crow Company. He reckons that whilst his input costs will go up – materials, contractors’ bills – this will be balanced by rising rents.

Forster’s contention is that the shed property market is so heavily out of balance – lots of demand, much less supply – that even the unwelcome shock of slower growth and higher inflation can’t knock it off its perch.

“Yes construction costs will keep going up – we’ve already seen them rise by 15-20% in 2021 – and but rents are also rising, and each side of the equation will neutralise the other,” he told SHD.

“What’s been driving up rents hasn’t changed because we now have inflation. We have record low vacancy levels – about 2.6% of space is vacant – and a paucity of supply, and significant amounts of capital wanting to deploying into investing in and building warehouses. In uncertain markets like today’s logistics property is more attractive, not less.”

Forster guess there may be some pauses for thought, or to gather breath, but the trend of the last three or four years will continue.

“Look at the numbers. Last year in the UK operators took 50 million sq ft of new Grade A warehouses. Today we’ve about 17 million sq ft available, and another 8 million sq ft under development. So whilst everyone will show some caution, I don’t share the view that something fundamental in the market has changed,” he says.

Forster points out that even if demand for warehousing scaled back, the shortage of supply means there still wouldn’t be enough floorspace for everyone who wanted it. A 2008-style crash seems unlikely, he says.

Hardly anyone of working age today was working the last time inflation hit the heights in the 1970s and 80s. We are all flying blind. Even so, there is no denying surging inflation and flattened growth will have impacts on the worlds of logistics and logistics property. Trouble is, nobody is yet sure what.

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