Factors Affecting Industrial Real Estate | By Richard Matthews
Overview
It is no secret to anyone that yields have been compressing in Industrial real estate for the last 10 years. Sales volumes in 2021 have never been so high. Quality stock continues to sell off market in days.
And yet this is in contrast with significant changes in other asset classes like Equities for example. Nothing catastrophic, but stocks are down on highs earlier this year. Interest rates have also knocked the wind out of Residential real estate on Australia’s east coast. So is Industrial property an outlier? Is it the Golden goose to keep laying Golden eggs? With Industrial vacancy rates in Sydney at less than 0.5%, it may well be for some time to come. But what would change look like? How would some early indicators of changes to Industrial Real Estate materialise?
I looked at two academic papers that propose some interesting findings. Links and summaries of these papers are below. The first looks at the correlation of Equities and REITS which in summary is strong. Equities values are declining off highs so the takeaway is that REITS may track Equity values at some point also. The second paper finds that as uncertainty levels rise such as during credit tightening, the correlations of asset classes actually gets stronger. The paper goes on to look at Uncertainty Indexes which is an interesting early indicator to keep an eye on also.
So timing aside (as who knows), the longer term outlook for industrial property would be to track other asset classes. This assumes REITS are a good barometer of industrial property in general. Given REITS compete for industrial assets with institutional and private buyers and businesses I would suggest they are. On the flip side is Industrial vacancy rates which are historically low. I grew up driving around industrial estates being blinded by ‘for lease’ signs. That is all gone for now. Businesses are struggling to find premises to grow into. Rent rises are given for industrial tenants which is a great inflationary hedge for industrial landlords. So as an asset class with yields approaching the almost risk-free Australian Government 10 year bond rate (3.55%), Industrial still looks strong. The point in highlighting these papers is to gain an understanding of what larger forces may be at play.
Sydney Industrial Cap Rates: Source: MSCI Real Capital Analytics
paper 1
A comparative analysis of listed and unlisted real estate investments (2018)
- REITS, Stocks, Bonds, Money are affected by Common Macroeconomic factors.
- Information linkages seen in Volatility, not Returns.
- REITS are influenced by stocks
- REITS are influenced by bonds also but less correlation. REITS share with bonds:
- Steady cash flows
- Long term leases
- High credit tenants
- High REIT dividend yields
- Expect a stronger volatility link with Stocks and REITs as they are on the same exchanges.
- REIT market volatility has greater correlation to large cap stocks and less for low cap stocks.
- Stocks and REIT Returns 0.79 correlated. Both looking at:
- GDP
- Inflation
- Unemployment
- Interest rates
- Macro news
- Bonds much less correlated at -0.21. So Bonds are a good way to diversify from real estate and Stocks.
- Very little Return correlation for REITS to Money.
- So same information leads to different results = Volatility is correlated and Returns are not (Other than Stock and REITS Returns)
- Table shows difference in Implied Volatility:
- REITS and Stock returns correlation .79
- REITS and Stock Volatility correlation .88 so higher
Citations
Andrine H. Nygaard and Henrik Bull Svarva
Paper 2
On the Economic fundamentals behind the Dynamic Equi Correlations among Asset classes: Global evidence from Equities, Real estate, and Commodities (2021)
- “That elevated cross-asset correlations are associated with higher uncertainty, tighter credit conditions, and lower geopolitical risk, while
- Lower correlations are related to stronger economic activity, business, and consumer confidence
- Economic policy uncertainty (EPU) as a potent catalyst of the asset markets integration process and conclude that EPU magnifies all macro-effects across all correlations
- Six macro-Financial factors; i) policy and ii) Financial uncertainty, iii) credit conditions, iv) economic activity, v) investors sentiment (business and consumer), and vi) geopolitical risk
- Finding underscores the importance of policy uncertainty that exacerbates all cross-asset correlations and partly drives likewise the other Five macro-effects with an inflating impact.
- A significant negative signed effect for economic activity proxies, investor sentiment, and geopolitical risk,
- While heightened Financial uncertainty and tighter credit conditions are positively related to correlations, alike the policy uncertainty influence. Australian data https://www.policyuncertainty.com/australia_monthly.html See Graph.
- As confidence drops and uncertainty rises, correlations become higher.
- The global geopolitical risk index is found significant only in the two correlation combinations of commodities (with equities -MXWO & GSCI- and real estate -GSCI & REIT).
- We reach an intriguing and novel result for the macro-finance literature: Higher geopolitical risk means lower correlation of the commodity market with the other two risky assets, while equities-real estate correlations are not affected by the geopolitical proxy. This Finding contradicts a reasonable expectation that geopolitical tensions often inducing or urging overall uncertainty would increase correlations.
- that higher policy uncertainty means stronger effect of Financial uncertainty, credit conditions, economic activity, business, and consumer sentiment, and geopolitical risk on cross-asset correlations.
- nel. In other words, EPU partly drives or explains the macro-determinants of equi correlations amplifying their effect
- policy uncertainty in a major economy is not confined to the country’s borders but is propagated across the global markets immediately
- Consumer confidence is significant only for the equities-real estate correlations with a negative sign, and, more interestingly, higher geopolitical risk decreases the two commodity correlations with equities and real estate, leaving the equities-real estate pair without geopolitical repercussions.”
- EPU as of late August, China has significant activity https://www.policyuncertainty.com/index.html
- So when things are you good you can get differences between asset classes and when the economy is tightening the asset classes are more likely to do the same thing.
- At present, equities are certainly bearish so it may not be long before we start to see some yield growth in parts of commercial property.