Ukraine Crisis to Reverberate Across Global Economy U.S. Real Estate Positioned to Withstand Impacts
The humanitarian, social and political crisis unfolding in Ukraine has begun to deliver some economic fallout in both global and United States markets. Oil prices have surged, the stock market moved into correction territory and a flight-to-safety pushed interest rates lower. As the war plays out over the coming days, weeks or perhaps months, a wide range of economic consequences could emerge. Setting aside worst-case scenarios, the war in Ukraine likely holds little direct risk to U.S. commercial real estate. Although some ripples will likely be felt by investors, hard assets have historically demonstrated durable results in times of turbulence and uncertainty.
Inflation Risks Intensify as Oil Prices Surge
- War having clear and immediate impact on energy costs. Russia is one of the world’s top oil producers, delivering about 12 percent of the global supply, and oil is the country’s most valuable export. The financial sanctions already placed on Russia in the wake of their invasion of Ukraine, together with the U.S. oil boycott and rising global public pressure to shun Russian products, will weigh on the country’s ability to export oil. This is placing new strains on global oil supplies, sparking a surge in energy prices. Oil prices were already on the rise, prior to the invasion.
- Increasing fuel production comes with host of hurdles. If oil shortages amplify, international strategic reserves will be tapped to cover the short-term needs. Over the longer term, U.S. energy companies could ramp up production by an estimated 600,000 barrels per day, on top of the 11-12 million barrels the U.S. currently produces.
Interest Rates Face Complex Outlook Amid Monetary and Financial Cross-Currents
- Fed’s balancing act just became more complicated. The Federal Reserve faces a new set of challenges in its battle with inflation, as the war in Ukraine introduces a range of new variables. The stock market correction, with an ensuing flight-to-safety, placed downward pressure on long-term interest rates, while expectations of Fed rate hikes have applied upward pressure on short-term rates.
- Consumer sentiment key to stagflation risk. Prior to Russia’s invasion of Ukraine, the prospects of stagflation — where inflation is high but real economic growth stalls — were nominal. Despite this, the added pressure created by rising fuel prices and a potential yield curve inversion, in conjunction with the ongoing labor shortage and supply chain problems, could dampen economic growth.
- Multiple policy tools still on the table for the central bank. The Federal Reserve has reiterated its commitment to raising the overnight rate by 25 basis points on March 15, but plans beyond that are likely fluid, as Fed leaders closely monitor market conditions. Raising interest rates is the most prominent tool available in the Federal Reserve’s efforts to rein in inflation, but it tends to be a slow process.
- Current conditions partially tighten capital liquidity. In light of added uncertainty, lenders have begun to assume a more cautious stance. Some financiers have begun to reopen their spreads and tighten their leverage requirements. Thus far, the movement has not been significant or broad-based, but if the war in Ukraine escalates, either militarily or through cyberattacks, lenders may adopt a more conservative posture.
*As of March 9
Source: Federal Reserve
Inflation Resistance and Stability Underpin Real Estate Advantage
- Macroeconomic factors highlight real estate attributes. The increasingly complex geopolitical, economic, financial market and inflation landscapes have aligned to reinforce the investment advantages of commercial real estate. Many of the factors weighing on the economic outlook and driving inflation, such as material, equipment and labor shortages, will restrain commercial real estate construction. This will help keep vacancy rates low and boost the commercial real estate revenue outlook.
- Real estate stability increasingly valued by investors. Even the most seasoned political and military experts cannot predict how long the Ukraine crisis will last or what the ultimate outcome will be, but the economic and financial market ripples have already become readily apparent. Within this context, the combination of yield, stability and inflation resistance of real estate will become increasingly valued by investors, supporting transactional activity in the sector. Even after hostilities in Ukraine end, the impact of the war will resonate. Any potential rebuilding of Ukraine could spur global economic growth.
Key Demand Drivers Supporting the Commercial Real Estate Outlook
- While the U.S. economy certainly faces headwinds, and the war in Ukraine has increased the risk of a recession, core underlying drivers continue to support commercial real estate space demand. Positive demographics remain a key factor supporting the housing market, as millennials age into the prime rental cohort.
- The wind-down of mask mandates across the U.S. will be another factor supporting commercial real estate demand, particularly in office and retail space. Many companies have reinitiated plans to return to the office, while consumers are once again venturing into retail stores, restaurants and entertainment venues. Hotels will also be a beneficiary of the changing mask rules, particularly if businesses capitalize on this change to reinitiate business travel.
- Self-storage demand outpaced expectations through the pandemic, and the construction pipeline for these properties has declined over the last two years, allowing the sector to achieve record-low vacancy rates. The proven recession resistance of self-storage will remain a top feature, attracting capital seeking diversification.
- Supply chain disruptions reiterated the need for businesses to maintain sufficient local inventory to cover logistics lapses, bolstering industrial space demand. The sector has also benefited from increased use of e-commerce platforms that leverage industrial space as an integral component of the sales fulfillment process.
Mitigating Downside Risks
Commercial real estate offers long-term durability. The war in Ukraine will remain fluid, and even after the invasion ends, there will likely be considerable geopolitical instability across the region. Allegations of war crimes, potential radiation hazards, the displacement of millions of people and the destruction of entire cities will impact the global economy and political landscape long after the shooting stops. While there are some upside scenarios, downside risks are far more numerous and broad reaching.
Sources: BLS; New York Times
The information contained in this report was obtained from sources deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guaranty, express or implied, may be made as to the accuracy or reliability of the information contained herein. This is not intended to be a forecast of future events and this is not a guaranty regarding a future event. This is not intended to provide specific investment advice and should not be considered as investment advice.
Sources: Marcus & Millichap Research Services; Federal Reserve; CoStar Group, Inc.; Moody’s Analytics; MNet; NICMap; Real Capital Analytics; RealPage, Inc.; Yardi Matrix; Radius+; U.S. Census Bureau; U.S. Bureau of Labor Statistics; U.S. Energy Information Administration