War in Ukraine and US Commercial Real Estate: No Direct Hits, But Glancing Blows Aplenty

Russia’s invasion of Ukraine rapidly devolved into a humanitarian crisis, a political minefield and an economic drag. But the largest military conflict in Europe since World War II seems unlikely to directly affect the commercial real estate sector. Instead, the impacts will be indirect ones, in the form of higher oil prices, slower economic growth and yet more supply chain issues. What’s more, the war will complicate the Federal Reserve’s efforts to rein in inflation.

Any analysis of how the war might affect commercial real estate values starts with this reality: Russia and Ukraine aren’t major investors in U.S. assets, nor are they meaningful drivers of U.S. economic activity. While Russian President Vladimir Putin plays an outsized role on the international stage, his citizens are not especially important players in U.S. commercial real estate markets. Russian nationals are active buyers of residential real estate in some U.S. markets, but overall they account for less than 1% of all transactions by foreign buyers, the National Association of Realtors says. “Russia has little direct impact on the U.S. real estate market,” NAR economist Gay Cororaton wrote in a recent blog.

Russians’ role as users of commercial real estate might be an even smaller one. In a prominent exception, RT America, a U.S. television network controlled by the Kremlin, operated from a headquarters office in downtown Washington, D.C., one it presumably will vacate after ceasing operations. But RT America is the rare example of a Russian company downsizing U.S. operations as a result of the war – simply because there aren’t many Russian multinationals. Russia’s economy is based largely on oil production and cronyism, and it doesn’t have a deep bench of private companies that are efficient and innovative enough to compete in the U.S. market. Russia was the world’s 11th-largest economy based on 2020 GDP, according to The World Bank. Despite its size, Russia is only a minor trading partner with the United States. Neither Russia nor Ukraine ranked among America’s 15 largest trading partners in January, according to the Census Bureau.

While the war sent stocks into correction territory, commercial real estate values didn’t take an immediate hit, said Constantine Korologos, clinical assistant professor at New York University’s School of Professional Studies at the Schack Institute of Real Estate. “Real estate assets aren’t subject to the same volatility, the jumpiness, movement in the market that equity markets are,” Korologos told Commercial Property Executive.       

On the humanitarian front, Ukraine said hundreds of civilians died in the early weeks of the war. Western media showed images of wounded children, fleeing women and bombed-out neighborhoods. Politicians in the United States and Europe responded with a spate of sanctions aimed at trade with Russia and the foreign assets of Russian oligarchs. The United Kingdom also joined in. While critics had used the phrase “London laundromat” to describe the phenomenon of rich Russians hiding assets there, the UK has ramped up its sanctions.

An Early Casualty of War: Gas Prices

Perhaps most crucially for the global economy, Russia is one of the world’s largest producers of oil. Russia accounts for some 12% of the global supply of crude oil, The World Bank reports, and petrol is the nation’s most valuable export. In response to Russia’s invasion of Ukraine, the Biden administration boycotted Russian oil. President Joe Biden acknowledged the move would lead to pain at the pump. “Defending freedom is going to cost,” Biden said.

Amid intensifying public pressure to shun Russia’s exports, global oil supplies face fresh constraints. As a result, energy prices rose sharply. Even before Russia’s incursion into Ukraine, oil prices had been rising from the nadir they reached early in the coronavirus pandemic – oil prices briefly went negative in 2020. By early 2022, oil traded in the range of $75 per barrel. Oil prices climbed 20% as of Feb. 23, the day before Putin sent troops into Ukraine. Since the invasion, oil prices have jumped further. Prices touched $130 per barrel after the U.S. announced its oil boycott March 8. That’s a 70% surge in just a couple months, and the sharp climb pushed U.S. pump prices to record highs, above $4 a gallon. This oil shock is a new phenomenon, but it raises old questions about U.S. consumers’ tolerance for inflation. Will they shun commutes and insist on working from home even longer, therefore damping demand for office space? Will staycations become the rule for the summer travel season, and reduce demand for hotels? Will e-commerce companies boost delivery charges in a way that causes consumers to spend less?

Because pump prices are so visible – gas stations post their prices for all to see, and the media breathlessly covers spikes in gas prices – gas prices have an outsized effect on consumer confidence. Economists consider gas increases to be akin to a hidden tax, but a spike in pump prices by itself won’t send most consumers into bankruptcy. A motorist who drives 15,000 miles a year in a car that gets 30 mpg buys 500 gallons of gas a year. At $4 a gallon, that tab is $2,000 a year, up from $1,000 a year if pump prices are $2. In other words, a typical consumer probably budgets more for lattes and microbrews. But the unplanned nature of oil shocks can make rising pump prices feel onerous. What’s more, a sharp, sustained rise in gas prices would raise the risk of the U.S. economy going into recession.

Beyond the gas pump, rising oil prices will spur further inflation, which hit a lofty level of 7.9% in February. Higher petrol prices push up costs of manufacturing, transportation and plastics. Consumers and commercial property users will feel the pinch in the form of higher prices for electricity and airline travel. The intensity of the inflationary increase hinges on many factors, but the oil shock could push up consumer prices by a percentage point or two in 2022, commercial real estate firm Marcus & Millichap says. If oil shortages persist, U.S. energy companies could increase production, while Iran, Iraq, Saudi Arabia, the United Arab Emirates and Venezuela also could boost output. However, oil producers can’t ramp up production quickly or easily. “Even in the U.S., ramping up production will face logistical hurdles, including labor and equipment shortages, that reiterate the challenges faced by the sector,” wrote John Chang, senior vice president at Marcus & Millichap.

Russia’s economic scope extends beyond crude oil. It accounts for a quarter of the global supply of natural gas, 18% of coal production and 14% of the market for platinum. “A steep drop in the supply of these commodities would hamstring construction, petrochemicals and transportation,” The World Bank’s Indermit Gill wrote. “It would also lower economywide growth. Oil prices have risen by more than 100% during the last 6 months. If this lasts, oil could shave a full percentage point of growth from oil importers like China, Indonesia, South Africa, and Turkey.”

Other economic fallout remains unclear

The war’s impact on energy costs was almost instant. But it’s unclear how the conflict’s fallout might play out in other, slower-developing ways. Major Western economies were unified in imposing sanctions on Russia, and the private sector piled on with voluntary bans on selling to Russia. Those moves are roiling stocks and slowing economic growth. In the U.S., the Federal Reserve already faces a challenge of managing inflation that had hit 40-year highs even before war in Ukraine. Investors have sought out safe havens, a shift that created downward pressure on long-term interest rates. At the same time, nearly everyone expects the Fed’s Open Markets Committee to raise the federal funds rate by 0.25 percentage points at its March 15-16 meeting, and those expectations are pushing up short-term rates.

The result is a flatter yield curve. As the spike in gas prices intensifies inflation, the Fed now is forced into a balancing act: It must calm inflation without tipping the economy into recession or stagflation, a period marked by the unfortunate combination of stagnant job growth and rising inflation. Before Russia’s military began bombing Ukraine, no one mentioned stagflation. Any comparisons of the 2020s and the late 1970s were confined to a recitation of inflation rates then and now. However, the war in Ukraine came at an uncertain economic moment. Central bankers were struggling to respond to labor shortages and supply chain problems. A jump in fuel prices and the possibility of an inverted yield curve only raise the Fed’s level of difficulty. And, it’s worth noting, while the Fed won kudos for acting quickly in response to the coronavirus recession, the central bank hasn’t gotten much praise for its misreading of the inflation that followed the US government’s massive stimulus. Fed Chairman Jerome Powell insisted that rising prices were “transitory” even as many observers doubted that assertion.

Even before the outbreak of war in Ukraine, the Fed had planned to raise its overnight rate in a bid to slow inflation. However, pushing the overnight rate as a lever grows more challenging should the yield curve remain flat. One option for the central bank could be quantitative tightening, such as selling off long-term bonds and mortgage-backed securities held on the Fed’s balance sheet. “Quantitative tightening would reduce the Fed balance sheet, which doubled during the pandemic, while also putting upward pressure on long-term interest rates, like the 10-year Treasury,” Marcus & Millichap’s Chang wrote. “Implicit to that strategy would be higher borrowing costs for commercial real estate investors.”

The Bottom Line

Neither Russia nor Ukraine are major trading partners with the U.S. or major investors in U.S. commercial real estate, so the war is unlikely to directly impact property markets. However, the war already has led to rising oil prices. Record-high gas prices were intensified by the U.S. boycott of Russian energy products. Should the oil shock push the economy into recession, user demand for commercial real estate would decline, and investor demand would be dampened, too.

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