How might escalating trade tensions with China and our other trading partners affect commercial real estate? Today we bring you a round-up of some of the expert commentary surrounding these concerns and provide our take as to what we’re seeing in the market.

1) Steel tariffs may be putting pressure on commercial construction pricing, creating opportunities as well as risks.

Some in the sector say they have seen around a 10% increase in the price of steel since the tariffs were announced in March. Distortions in the market may slow development deal flow somewhat, but with demand still strong at the midpoint of the business cycle, the greatest impact could be a shaving of returns among offerings by sponsors who were not conservative in their cost underwriting. Value-add offerings could stand to benefit from rising constructions costs, as already-constructed buildings may be able to command higher rents in competition with newly-constructed buildings needing to recoup higher-than-expected costs.

Source: NREI

CrowdStreet take: While it is true that we’ve seen a few proposed developments negatively affected by the recent spike in steel prices (and the data suggests some long-term correlation between construction costs and iron and steel prices does exist), from our vantage point, the primary driver of escalating construction costs remains a scarcity of skilled labor, and most notably in cities with the greatest amount of active construction.

2) US tariffs on Chinese imports (and retaliatory Chinese tariffs on US exports) may greatly impact port cities.

The goods shipped to and from China through US port cities support hundreds of thousands of jobs across these MSAs. Reducing this flow of goods could lead to layoffs that ripple through the local economies and weaken regional real estate demand dynamics.

Chart 1: Top US port cities exposed to US-Chinese trade

Sources: CNBC, World Port Source

CrowdStreet take: We have yet to see any signs of market distress associated with US port activity. Given its dominance, the Los Angeles metro would be a leading indicator, so we are keeping an eye on this market, but we currently have no reason for concern.

3) Rising volatility in equity markets on trade war fears could make direct commercial real estate investment a relatively safer haven for investment capital.

So far, the US equities markets have been far less reactive than other world markets to news surrounding the potential for international trade wars with only 4% of total US trade currently affected, though that may not remain the case as pending/threatened tariffs may swell affected US trade to 22%. Traditionally, direct commercial real estate investment has experienced significantly less volatility than most other asset classes, and in terms of risk-adjusted returns, direct commercial real estate investment surpasses all comparable alternatives.

Chart 2: US equities market performance vs. Asian and European peers (2018 to date)

Chart 3: Volatility and risk-adjusted returns across asset classes (annualized performance for 20-year period ended 12/31/16)

US. equity Non-US equity US fixed income Direct real estate REITs
Total returns 7.86% 5.05% 5.29% 9.31% 9.67%
Standard deviation (volatility) 18.46% 21.86% 3.63% 11.37% 19.59%
Sharpe ratio (risk-adjusted returns) 0.31 0.17 0.43 0.55 0.30

 

Sources: CBRE, TIAA

CrowdStreet take: We have noticed some of this type of activity from investors in 2018 but it has been mostly attributable to a general desire to exit equity markets due to a combination of near-records highs and greater overall volatility (particularly in February). We have yet to hear investors cite trade tensions as a reason to exit equity markets. When investors do exit equity markets to redeploy funds into commercial real estate, they are generally seeking deals with reasonable certainty of cash flow rather than more speculative situations (e.g. development).