In the latest developments of the Ukraine-Russia conflict, international businesses and global leaders (even historically neutral Switzerland) have swiftly and powerfully responded to the Russian invasion of Ukraine*. Financial sanctions imposed by the U.S. and the United Kingdom are the toughest economic penalties ever imposed on a country of Russia’s size, with an aim to both shock the country’s economy and weaken its access to financial resources. Some of the major sanctions imposed so far include:
- Freezing Russian central banks¹ assets held in the U.S., curbing their ability to use $630bn (£470bn) of its international reserves to support their currency. The value of the Russian ruble² quickly plunged in response.
- Banning several Russian banks from using SWIFT³, the global messaging system that enables bank transactions. This has disrupted the country’s ability to do business across borders and overseas.
- The U.S. ban on Russian oil, Liquefied Natural Gas, and coal.
- Imposing restrictions on top Russian oligarchs with political influence, including freezing access to their assets in the U.S., as well as visa restrictions.
The global economy is undeniably interconnected. There are bound to be long-term ramifications of these sanctions that escape prediction, but at this time, the economic outlook outside of Russia isn’t as grim as you might fear, even as the public markets brace for another wave of uncertainty.
When considering the commercial real estate (CRE) market, we expect to see minimal direct, although some indirect, effects.
Russian Investments Do No Drive Global Market Dynamics
As Real Capital Analytics pointed out in a recently published report, Russian capital has very little presence in the global market. Over the last five years, the average amount of capital that flowed from Russia to other countries averaged just $330 million per year. The report also points out that “known Russian ownership of commercial assets in the world’s largest property markets is sparse”. This is especially true in the U.S., where Russian investment is negligible and not a major driver of market dynamics.
CRE Is Local And Less Volatile Than The Stock Market
While all investments carry a certain level of risk that can be tied to market fluctuations, due to its intricate and global nature, the stock market is typically more prone to volatility during geopolitical turmoils. Real estate is usually less connected to the whims of the stock market and we expect limited direct impact to locally-based hard assets, with cash flow and return on CRE investments to remain largely protected. Compared to the stock market which has been on a roller-coaster ride in the face of rising inflation and uncertainty due to the war, CRE may offer a hedge against rising inflationary pressures, particularly, especially for asset classes where property owners can adjust rents and net operating income quickly. The dynamic feedback we are currently receiving from sponsors that are bidding on CRE assets supports this notion. In an environment where the stock market is correcting, typically the pricing and demand for CRE acquisitions remain as strong as we had experienced back in January of this year.
There May Be Some Indirect Consequences
While direct effects are likely minimal, we acknowledge that indirect consequences from sanctions, especially a rise in the price of inputs, may exert pressure on the CRE market.
For example, as goes the price of oil so goes the price of asphalt. With the announcement of the U.S. ban on Russian oil imports, Brent crude oil surged over $130 per barrel4 in the second week of March. Our Investments team is keeping an eye on our pipeline for projects that rely on asphalt, particularly those that have not yet locked in their pricing. To this end, President Biden’s announcement that the U.S will release 60 million barrels of oil from the strategic reserve was welcome news. In support of Ukraine, Exxon Mobil announced its exit from Russia, discontinuing its current operations and halting plans for any future investment. While Russian oil exports account for about 8% of the global supply, if more nations stop importing oil from Russia, it could further tighten the oil market and put upward pressure on the price of oil. We are already seeing the impact of rising oil prices on an already inflamed inflation number, which further increased to 7.9% in February 2022.
The current conflict could also put further strain on the already distressed global supply chains in the days ahead. The recovery of our global supply-chain issues is essential to stabilize the economy, especially as it relates to building material costs that impact CRE development and property values.
The Situation Is Fluid
There are multiple variables at play, many of which can counterbalance each other as the situation evolves. As the invasion of Ukraine continues, it’s certainly possible that our perspective will change. Should the U.S. forecast for 2022 GDP growth (3.2% this year according to Goldman Sachs) change, we will quickly reevaluate our outlook for the rest of the year. However, if the GDP forecast changed, we would also expect the Fed to respond accordingly and revisit the number of interest rate hikes it has telegraphed for 2022. The Fed already revisited their initial interest rate hike plan and proposed a quarter-percentage point rate increase in the upcoming meeting in order to “proceed carefully”5 during the current uncertain climate. We wouldn’t be surprised if they also postponed one or more of the planned interest rate hikes, which could spur a new wave of demand for commercial real estate. While the current conflict can and may intensify, we must remember that our government does possess tools to help maintain our economic course.
There’s no question that the economic sanctions being used to curb Russia’s ability to continue military action in Ukraine are unprecedented (and rightfully so), both in how quickly they were issued and in their severity. While it is prudent to remain cautious about the consequences of international warfare on the U.S. economy, we believe that the U.S. CRE market will remain largely insulated from major direct impacts because of the asset’s low market volatility, its localized presence, and its ability to hedge against rising inflation. We recognize that indirect impacts such as the rise in the price of oil, continued supply-chain disruptions, and an increasing inflation rate could interfere in the development and ultimately the value of CRE, however, at this time, we are seeing momentum among market participants that are bidding on CRE assets, which is telegraphing to us that it remains an attractive outlet for investable capital. While some hesitancy is to be expected among investors, businesses, and stakeholders in the CRE space, especially if international tensions worsen, we believe the perception of CRE’s value and its demand remains as strong as it was at the beginning of the year, if not more.
To understand how we are viewing CRE investment opportunities going into 2022, please access our Investment Thesis which can be found here. We will continue to monitor the markets and update our outlook for the investor community, accordingly.
*As of March 11, 2022
1. Rappeport, Alan. “U.S. Escalates Sanctions with a Freeze on Russian Central Bank Assets.” The New York Times, The New York Times, 28 Feb. 2022, https://www.nytimes.com/2022/02/28/us/politics/us-sanctions-russia-central-bank.html.
2. Cohen, Patricia, and Jeanna Smialek. “The West's Plan to Isolate Putin: Undermine the Ruble.” The New York Times, The New York Times, 28 Feb. 2022, https://www.nytimes.com/2022/02/28/business/russia-sanctions-central-bank-ruble.html.
3. Zorthian, Julia. “What Are the New Swift Sanctions and Their Impact on Russia?” Time, Time, 2 Mar. 2022, https://time.com/6153951/swift-sanctions-russia/.
4. Dezember, Ryan. “Oil Tops $130 a Barrel as Russian Attacks Escalate.” The Wall Street Journal, Dow Jones & Company, 7 Mar. 2022, https://www.wsj.com/articles/oil-buyers-paying-record-premiums-for-prompt-deliveries-11646518865?mod=article_inline.
5. Timiraos, Nick. “Powell Says Fed Is on Track to Raise Rates in Two Weeks.” The Wall Street Journal, Dow Jones & Company, 2 Mar. 2022, https://www.wsj.com/articles/powell-says-fed-is-on-track-to-raise-rates-in-two-weeks-11646227811?mod=article_inline.
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