Greater Seoul logistics: light at the end of the tunnel?

Investor sentiment towards Greater Seoul’s logistics properties has weakened considerably over the past 12 months. The main reasons for this have been higher financing costs and a surge in new supply. The total stock of Grade A logistics space in Greater Seoul jumped 65% between the end of 2021 and June 2023, according to CBRE’s estimates. This raised vacancy rates from a low of 1% to 17% over the same period.

While the near-term outlook remains challenging, as the market continues to digest the new supply, there are two reasons why we think we might be seeing light at the end of the tunnel.

Firstly, monetary policy tightening could be coming to an end, with the Korean five-year bond yield at 3.7%, as at the end of July (from a high of 4.3% at the end of October 2022). Apart from the impact on investment sentiment, we think this could have some indirect implications for demand. E-commerce demand for logistics space slowed following the withdrawal of initial public offerings from Market Kurly and Oasis Market in early-2023. But these could be revived as stock market valuations improve.¹

The pipeline of new supply appears to be tapering faster than we had anticipated at the start of 2023

Secondly, the pipeline of new supply appears to be tapering faster than we had anticipated at the start of 2023. According to CBRE’s latest survey, the projected stock level by the end of 2024 in Yongin and Pyeongtaek, for instance, is now 42% and 48% lower than their respective estimates at the start of 2023. Difficulties in accessing project financing have resulted in planned projects being delayed or abandoned, which suggests vacancy rates could stabilise sooner than expected.

This isn’t an oncoming train

“The light at the end of the tunnel is just the light of an oncoming train.” – Robert Lowell

Whether or not the light that we see is an “oncoming train” will depend on the strength of leasing demand for logistics space in Greater Seoul. We think there are some reasons to be optimistic.

Total online sales in Korea grew 7.3% year-on-year (YoY) to a record high of KRW55.5 trillion in the second quarter of 2023, bringing the 12-month tally to KRW217.2 trillion (7.9% YoY). While the YoY growth in the 12-months to June slowed to 7.9% (from 14.6% the year before), it still outpaced the 2.6% increase in Korea’s total retail sales (excluding motor vehicles and parts) over the same period. In other words, e-commerce penetration in Korea continued to rise, despite an already high rate of 35.9% at the end of 2022.²
Importantly, online sales of food & beverages (groceries, not food services) led the growth in the second quarter. The sector grew by 13% YoY, while online sales of cosmetics gained 5.7% YoY during the quarter. This suggests the underlying demand for temperature-controlled logistics space remains robust. But much of the new supply of cold-storage logistics space was speculatively built and doesn’t meet occupiers’ requirements.
The average vacancy rate for Grade A logistics properties in Greater Seoul jumped to 17% by the end of June 2023 (from 10% at the end of 2022), according to CBRE estimates. But considering the 2.9 million square metres (sqm) of new supply in the first half of 2023 was almost the same as that supplied during the whole of 2022 (3.2 million sqm), the implied net absorption was rather solid, in our view. This suggests that the growth in e-commerce is translating into higher demand for logistics space, especially in the dry-storage segment.

How far away is the tunnel’s end?

It may not be an “oncoming train”, but how far away are we from the tunnel’s end? If we were to define this as the point when vacancy rates fall back to sub-10%, then our estimates suggest the fast tapering of new supply has lowered the peak vacancy rate to 24% (from 35%) by mid-2024. This has brought forward “the end” by a year to mid-2025, where vacancy rates could fall to 9%. This is based on the following assumptions.

Korea’s e-commerce market continues to grow at an annual rate of 8% over 2023-27, or around half the pace of 2018-22. This dovetails with expectations from the likes of Euromonitor, which projects the share of online retail sales to exceed 50% of Korea’s total retail market by 2026.²
The increase in e-commerce sales is expected to translate into 3.6 million sqm of additional demand for warehouse space in 2024-25, or 100,000 sqm for every KRW1 trillion increase in Korea’s domestic e-commerce sales.

Based on the above estimates, there would be 24 million sqm of occupied Grade A logistics space that would service USD137 billion per year worth of online sales in Korea by mid-2025. This is still more productive than the USD2.2 billion per year per sqm in the US at the end of 2022. Considering capital markets typically move six-to-12 months ahead of the occupier market, we believe 2024 could be an opportune time for capital to be deployed into Greater Seoul’s logistics property market.