How Inflation, Iran War is Impacting CRE

Inflation is shaking the broader economy, but commercial real estate has yet to feel the tremors.

Energy price shock tied to the Iran war rippled through the economy in March, driving inflation to 3.3 percent annually, according to the latest report from the Bureau of Labor Statistics. Gas prices alone soared 21.2 percent from February, the largest increase since 1967.

The surge is already squeezing consumers. Inflation-adjusted weekly earnings fell 0.9 percent month over month and were up just 0.2 percent from a year earlier, denting spending power and potentially trickling down to landlords. Sticky inflation could also keep the Federal Reserve on hold, delaying hoped-for rate cuts and lower mortgage rates.

The 10-year Treasury — the key benchmark for CRE borrowing costs — briefly dipped below 4 percent in late February before the Iran-driven bond selloff pushed it back up to about 4.4 percent by late March. In the stock market, investors already seem to be pricing in an end to the war, with indexes nearly recovered from last month’s plunge.

But for real estate, any impact is likely to be slower and more muted. Rising maintenance and higher borrowing costs could eventually hobble landlords and suppress property values. But economists say those effects could take months to materialize.

This year’s rent growth is still expected to be positive across every sector except office, even as momentum cools, according to Oxford Economics data.

“It’s a slow-moving impact for real estate — it isn’t as rapid,” said Oxford’s Abby Rosenbaum. “We’re still expecting that this is going to be a recovery year for the real estate industry here in the U.S., but it’s a little bit weaker than what we expected.”

Consumer slowdown

Tenants are likely to remain cautious if consumer demand takes another hit, particularly in sectors like retail and industrial, Rosenbaum said. If consumers pull back on spending, retail landlords will have less room to push rents.

Strip malls are likely to feel the pressure most acutely, according to Green Street analyst Paulina Rojas Schmidt, while High Street retail remains relatively insulated, as its customer base tends to have more financial cushion to absorb market swings.

Even luxury — once largely considered recession-proof — isn’t immune to market pressure. LVMH, Kering and Hermès International have already flagged fallout from the Iran war, warning that it’s weighing on spending in the Middle East, a key customer base for the sector, according to the Wall Street Journal.

“In the Middle East, it’s tourist flows that are suffering more than the locals,” Kering CFO Armelle Poulou told the Journal.

That strain could trickle down to the hospitality sector. Cities that rely on international tourists may feel the effects of the sharp increase in jet fuel costs more acutely than domestic leisure markets, economists said.

Even the already struggling office sector, written off during the pandemic-era work-from-home shift, is proving more resilient than expected. But corporate tenants may eventually feel the squeeze. Airlines grappling with fuel costs, for example, could rethink their space needs across office and industrial portfolios, Columbia Business School professor Stijn Van Nieuwerburgh said.

Office rent growth was already expected to stay weak for the next several years as long-term leases signed before the pandemic continue to roll over, Rosenbaum said. A slowdown in investment or tenant demand could further dampen the sector.

Renters pull back

As households absorb higher costs for fuel, groceries and other essentials, rent growth could face resistance, particularly in multifamily. But residential rents are still expected to grow 2 percent nationally and 3.8 percent in New York City, according to Oxford data.

The direct impact on owners may be muted because utilities account for a relatively small share of landlords’ expenses and are often passed through to tenants, Van Nieuwerburgh said. The bigger risk is tenants’ ability to pay.

On the flip side, higher prices can be a tailwind for existing multifamily owners. Inflation supports rent growth, while elevated interest rates make new development more expensive, constraining supply, said Piper Sandler analyst Alex Goldfarb.

Still, uncertainty and risk are increasingly being weighed in investment committee discussions as investors grapple with an unclear outlook, Marcus & Millichap’s John Chang said during a recent webcast on the Middle East conflict. Those same investors view the current volatility as short term, with a long-term hold strategy in mind.

“As a result, I’m still seeing a lot of investors continuing to drive forward with their purchases and their dispositions,” Chang said.

Higher rates normalize

After the post-Great Recession era of unusually low rates, when real estate investors got used to cheap borrowing costs, we’re moving back toward more normal rate levels, Goldfarb said. The Iran war, he said, is unlikely to meaningfully alter that trajectory.

“I don’t see the outlook for real estate changing much now versus what we wrote about earlier this year, despite the Iran war,” Goldfarb said. “Overall, the economy remains fine, and oil — just like the 10-year — goes up and down. But it tends to be short-lived.”

While inflation tends to drive expectations of higher interest rates and put pressure on property values, consumers’ pent-up housing demand isn’t going anywhere, Oxford’s Barbara Denham said. Buyers have grown accustomed to waiting for mortgage rates to drop, but the delays are only compounding frustration.

“People are waiting and waiting for these interest rates to drop and this moves the needle further down the road,” Denham said. “In some ways, people are used to waiting, but it just aggravates the frustration, because each year, there’s more and more people coming into that phase of their life where they really want to buy a home.”