Long before Russia invaded Ukraine, supply chain challenges were driving up construction costs and inflation concerns were setting the stage for higher mortgage rates.
Now, just as recovery from the pandemic seemed within reach, Vladimir Putin’s war has the U.S. real estate industry bracing for its impact. Prices are rising further — reinforcing the Federal Reserve’s desire to push up interest rates — and global uncertainty is putting some commercial deals on hold.
The biggest immediate threat the crisis poses to U.S. commercial real estate is the ripple effect of a Russian financial crisis. When the country’s central bank defaulted on its debt in 1998, it triggered an international contagion, although on that occasion the effects were short-lived, according to Real Capital Analytics’ Jim Costello.
“The market at the time paused because suddenly financing dried up for a little bit,” he said, noting that borrowers were able to find other sources of capital. “The market ran right through that.”
Like the Trump administration’s tariffs on China, the Ukraine conflict is a strike at the atmosphere of free trade that has fueled real estate for decades, Costello said. Nations have responded to the invasion by isolating Russia economically, severing connections between the East and West.
“We’ve lived in a charmed era since the 1990s where the steady march of globalization helped keep a lid on inflation,” he said. “We’re coming to an end with different trading blocs emerging.”
On Thursday, a Deutsche Bank executive said it was not “practical” to end its operations in Russia. Within 24 hours, the bank changed its tune.
“We are in the process of winding down our remaining business in Russia while we help our non-Russian multinational clients in reducing their operations,” the bank said in a statement. “There won’t be any new business in Russia.”
Supply chain roadblocks
The construction industry’s pandemic issues have been well documented. Projects were delayed because windows or door hinges took ages to arrive and workers became harder to find. Despite Ukraine’s relatively minor role as a U.S. trading partner, the conflict is expected to further drive up costs and complicate project timelines.
“It means that the slightest blip in the radar can have profound impacts on global markets, and further strain the global supply chain,” said Gregg Healy, who runs Savills’ industrial arm in North America.
Last-mile properties, perhaps real estate’s hottest asset class, will see even greater interest from investors as businesses seek to reduce delivery times by using distribution centers closer to consumers.
“This will only further put pressure on industrial real estate demand,” said Healy.
Russia is among the world’s top producers of nickel, steel and aluminum, and the war has roiled markets for construction materials. Nickel, used in steel and lithium batteries, hit an all-time high of more than $100,000 per ton on March 8, causing the London Metal Exchange to halt trading on the material for the first time in three decades, according to Bloomberg. Trading is slated to resume Wednesday. Sanctions have also caused spikes in aluminum and copper prices.
“There’s no sign that those prices are coming down,” said John Robbins, who heads U.S. real estate for construction consultancy Turner & Townsend. “We are going to see a very, very rocky supply chain to come.”
Robbins said suppliers have started tacking on fees for heightened fuel costs, and construction managers are condensing the time frames in which they will guarantee a total contract price. He added that clients are increasingly skittish about starting projects, though few have the ability to stall until market conditions are less volatile.
“It feels like we cannot get ourselves out of this cyclone of perfect storms,” he said, “And we have not seen the worst of it yet.”
Rates on the rise
The immediate impact in the U.S. largely boils down to inflation: To curb rising costs, the Federal Reserve is expected to raise interest rates, perhaps more aggressively than originally planned. It raised rates by 25 basis points on Wednesday, a move that had been expected was the first increase since 2018, and signaled six more hikes to come this year.
Housing demand was at a fever pitch during the pandemic. Bidders in some markets lined up for hours to tour any reasonably priced home. Institutional investors such as Blackstone have also gobbled up single-family homes as rentals, further compressing inventory.
Higher mortgage rates are adding to homebuyers’ woes. By March 10, a 30-year fixed-rate mortgage averaged 3.85 percent, up from the previous week’s 3.76 percent, according to Freddie Mac. The average rate last year was 2.96 percent.
The Federal Reserve is largely expected to follow through with its planned rate hikes this week, but “uncertainty about the war in Ukraine is driving rate volatility that likely will continue in the short term,” Sam Khater, Freddie Mac’s chief economist, said in a statement.
For now, buyers still largely view rates as relatively low, said Taylor Marr, an economist at Redfin. “There’s a little bit of fluctuation from week to week, but overall we are seeing demand hold up,” he said in an interview. “The global conflict has not disrupted that.”
The housing market could still feel the ripple effects of the crisis. Higher gas prices could cool demand in certain markets, Marr wrote in February, and declining stock prices could cut into buyers’ ability to sell assets for down payments.
Meanwhile, according to a recent report by the National Association of Realtors, oil-producing states, including Texas, Alaska, Colorado, Wyoming, North Dakota, New Mexico and Oklahoma, are expected to see job growth as drillers increase production, in turn driving housing demand.
The crisis has economists and central banks on watch. Rate hikes are used as a check on inflation, and more broadly as a hedge against uncertainty. Lenders are watching the conflict unfold with similar concerns.
The invasion has already paused some bond deals, including $1.5 billion in commercial mortgage-backed securities financing for Deutsche Bank’s new headquarters in Columbus Circle.
According to Bloomberg, the deal at the Related Companies property is expected to proceed when market conditions improve. A $1.9 billion bond backed by an office portfolio owned by Columbia Property Trust and Allianz was also reportedly delayed this month.
Manus Clancy, a structured finance expert at Trepp, which tracks securitized mortgages, said that while some CMBS deals have been paused, no conduit deals — CMBS deals with multiple loans — have been delayed. He noted that lenders are requiring higher premiums because of the volatility.
“Spreads have widened, but not extraordinarily so,” he said. “Lenders are being more judicious.”
UPDATE, 3/16/2022, 4:48 p.m.: This story has been updated to include the Fed’s move today to raise rates.