Contracting demand explains industrials’ woes

03-05-2004

When it comes to non-residential property, industrials have not been the place to be, especially over the last decade.

In a healthy and mature economy with an expanding industrial sector, one would expect real industrial rentals to trend sideways over the full, long property cycle of about 17 years, provided building costs are used as a deflator, and provided supply is elastic.

But overall, real industrial rentals have been trending down since the early 1980s, which is a clear reflection of a contracting demand for industrial space, in turn the result of structural changes in the SA economy.

One industry that has been severely hit by these structural changes has been manufacturing, and the demand for local manufactured goods is an important proxy for the demand for industrial space.

Although the problems for SA’s manufacturing industry started in the early 1980s, the greatest damage has been done since the early 1990s. This followed the government’s abolition of tariff protection as well as SA’s re-entry into the global economy, which meant that the manufacturing industry was suddenly faced with increased competition.

Rode’s Report research editor Dirk De Vynck says other structural changes leading to the decline in the demand for industrial space include innovative technological advances that enable more being produced with less, whilst just-in-time inventory management and supply-chain management have allowed manufacturers and distributors to hold less stock.

Aggravating the situation has been the world-wide shift to the services sector of the economy. Thus, the dwindling contribution of the mining sector — a big feeder to the manufacturing sector on the Witwatersrand — to economic growth, impacted negatively on the SA manufacturing industry.

Another factor that may be depressing industrial rentals is the ageing factor in respect of the industrial-building stock. Because of the general weak demand for industrial space, not many new buildings have been added to the building stock over the last decade, and ageing buildings show lower market-rental growth than new buildings.

“The more recent performance in manufacturing is also not very encouraging, with most of the damage done by the rand’s unexpected appreciation since the last half of 2002 and the negative effect this has had on those manufacturers that are reliant on exports for their income. The decline in 2003’s manufacturing has been the worst since 1998, eroding the good performance noticed in 2002,” he says.

But early indications are there that manufacturing production may have turned the corner. Investec’s Purchasing Managers Index (Investec PMI) — which measures business activity at manufacturing level — has increased sharply since the end of 2003, which bodes well for the recovery in manufacturing production. We can say this because of the close correlation between manufacturing production and the Investec PMI over the last two years.

Furthermore, the overall trend in industrial vacancies over the last two years has been downwards, which indicates that demand for industrial space has been hotting up. All that is needed now for industrial rentals to lift off is a sudden resurgence in the demand for space, which, going by the predictions for the recovery in manufacturing production, may not be too far off.