On February 24th, 2022, Russia launched an invasion of Ukraine, an act that has caused grievous loss of life, precipitated a humanitarian crisis, and sent shock waves through the world’s economies. This ongoing military conflict and the evolving global response have implications that cross all borders, and Newmark will continue to monitor and assess the impact for our clients while, most importantly, hoping for a swift resolution to the crisis that is playing out on an individual, social and global scale.
At this moment, the United States appears to be the least-impacted among global industrial markets due to strong underlying fundamentals, continuing economic and labor-market recovery from the pandemic, and as a flight-to-safety destination for investors perceiving greater stability in American, dollar-denominated assets. However, uncertainty remains; as geopolitical turmoil persists, there are key areas of potential impact to monitor closely.
Inflation concerns are not exclusive to the industrial market but have wide-ranging implications therein; most prominently, implications for consumer spending patterns and their subsequent effect on industrial demand. Inflation reached an annualized rate of 7.9% in February 2022 prior to the Russian invasion, a height not seen in four decades, owing to the acute supply/demand imbalance in consumer markets driven by reaction to pandemic conditions. Americans were already spending a greater share of their budget on essentials like groceries, housing and transportation and less on discretionary spending, a trend that has been exacerbated by inflation. In January 2022, the average consumer spent 33% more on gas alone than in January 20211. Geopolitical turmoil will cause further increases in prices for energy, commodities and food (see additional detail below), meaning inflation will get worse before it improves. Recent economic forecasts for year-end 2022 inflation generally fall anywhere in the 5.0% to 7.0% range, and it is too soon to tell how much those forecasts will further shift2.
Industrial demand is fueled in large part by consumer spending on goods, which remains at elevated levels coming out of the pandemic. Many Americans are well-positioned to weather inflation due to wage-growth leverage in the tight job market and an improved household balance sheet post-pandemic. A February 2022 University of Pennsylvania analysis estimated that for most households earning over $20,000 annually last year, recent wage gains well exceeded inflation3. Should inflation worsen to the point of causing a significant correction in consumer spending, demand for industrial space will inevitably moderate from the record highs posted last year. This potential impact would not be realized until 2023 at the earliest, as many firms were unable to fulfill industrial real estate requirements in 2021 due to an unprecedented scarcity of industrial space. These same firms will be seeking opportunities this year in a market that faces record-low levels of vacancy.
Global Supply Chains
This conflict will further exacerbate existing sourcing and supply-chain challenges that were just starting to see a glimmer of resolution following two years of upheaval. Russia and Ukraine are major exporters of commodities, including oil, metals, food and agricultural products. The two countries combined account for almost a third of the world’s wheat exports, 20% of corn and 80% of the world’s sunflower oil. Russia is the third-largest global producer of oil and has a significant world-export share of a multitude of key metals and minerals, including 40% of the world’s palladium, 11% of global nickel production and 6% of the world’s aluminum, among others. Global sanctions against Russia have effectively removed these commodities from the open market, and supply will likely be constrained for at least the duration of the conflict. The global movement of goods are also disrupted: many maritime and air trade lanes have been diverted and shipping rates are trending higher as a result. National surface transportation networks will be stressed by higher fuel pricing due to roiled energy markets. These factors all stand to impact the national industrial market in a myriad of ways ranging from development to pricing to location strategy.
Most acutely, inflationary pressures on construction costs and persistent shortages of building materials will compound with rising land costs, acting as constraints to timely supply additions, further exacerbating space scarcity and driving rent growth in many markets. A longer-term impact is a global realignment of supply chains oriented in favor of the United States and reliable partners, particularly North and South American nations. The pandemic has already catalyzed a determined effort to expand domestic manufacturing and re-shore production as companies selling to American consumers increasingly consider a “make where you sell” strategy. Geopolitical security concerns around supply-chain resiliency will only strengthen this trend. More foreign direct investment may also flow to the United States, although restrictions on foreign investment in critical industries and infrastructure may continue to tighten. Domestic expansion and/or near-shoring to closer countries such as Mexico will require reconfigured supply chains, highlighting the importance of industrial space in different markets as routes are rewritten. Inventory volumes may also increase as firms consider strategic stockpiling to ensure product availability, weighing an increase in inventory-carrying charges against spiraling transportation costs and an unreliable supply chain.
As the top oil producer in the world, the United States imports only a small amount of Russian oil (8.0% of total imports in 2021), but Russia is the world’s third-largest producer, so actions taken against the country, including the Biden Administration’s decision to ban Russian oil imports entirely, have caused upheaval in energy markets. As of mid-March 2022, oil prices were up 58% from the start of the year, sending gasoline and diesel prices to record highs. Historically, gasoline and diesel prices have been slower to fall after a rapid rise. Ramping up oil production domestically and elsewhere abroad, while helpful, may take time to make a difference as oil companies are still emerging from a host of pandemic-related challenges.
For industrial occupiers, rapid cost increases have characterized the past two years, as everything from labor to real estate is now more expensive. However, these increases pale in comparison to the critical increases occupiers now face with transportation costs, in which fuel plays a notable part. Transportation is the single-largest expense center in the spectrum of logistics costs, generally accounting for 50% of total logistics costs4. As firms evaluate the impact that sustained higher-priced fuel will have on the balance sheet, closing the distance gap becomes paramount. Accordingly, leasing in core submarkets closer to households is likely to increase as consumer demand for product choice and timely delivery will continue to drive omnichannel strategy. With Americans facing pricing pressure at the gas pump, more may elect to have goods delivered to their door rather than driving to brick-and-mortar retailers, further intensifying demand for last-mile distribution facilities.
This sustained shock to the energy markets, while encouraging more fossil-fuel production in the immediate-term, may also serve to speed up public policy on green initiatives and accelerate the achievement of corporate ESG goals. Many industrial occupiers are already in the process of decarbonizing transportation networks and decreasing dependence on fossil fuels through fleet electrification for FTL, LTL, and localized delivery, a trend likely to gain even greater momentum.
Despite a current atmosphere defined by event risk, United States capital markets are well-positioned for resiliency during this crisis. Continued global volatility could benefit safe-haven and defensive assets, which includes institutional-quality industrial assets. Industrial product continues to benefit from immense investor demand, record pricing, positive leasing fundamentals and NOI growth.
Inflation is a top concern for investors and central banks. Newmark analysis of NCREIF data shows that with the exception of recessionary periods, industrial total returns have consistently outperformed inflation since the record-high inflation levels of the 1970s, adding credence to the notion that industrial real estate is likely to remain a good inflation hedge. However, the inflation rate is expected to outpace fixed rental rate escalations, which could impact real returns on properties with long lease terms remaining.
The federal response to inflation is also likely to have some impact on the cost of debt and consequently on levered IRRs. The Federal Reserve plans to raise interest rates this year, with market watchers anticipating anywhere from six to nine increases. Rising rates are not the only concern in the debt markets – general market and rate volatility have postponed several CMBS issuances in recent weeks, as some lenders wait for more clarity. Property types that have seen the greatest amount of cap rate compression and the tightest pricing are most susceptible to impact, as there is little room for increased costs of financing or lower levels of leverage without an offsetting rise in net operating income. This may, in turn, negatively impact demand from yield-focused investors, who will not be able to pursue certain industrial opportunities.
Industry and Employment
The geopolitical conflict has innumerable ripple effects, introducing potential challenges and opportunities in individual industries. Firms in sectors such as paving, mining, manufacturing and agriculture are more directly exposed to the volatility in oil and commodities which supply much of their inputs. Smaller firms in these fields may especially face significant financial impact5. On the other hand, the defense and security sectors are likely to benefit from higher security spending and a growing focus on business stability. In the United States, active job openings mentioning “cybersecurity” in the week of Russia’s invasion in February were up 50% over the same week in February 2021. In comparison, total active job openings were up 16.6% nationwide during that same period6. As noted above, reaction to geopolitical instability may spur some companies to expand domestic production or choose the United States for investment and development, particularly in relation to advanced manufacturing. This presents positive opportunity and growth for the national industrial market and the economy, although the availability of skilled labor in the advanced manufacturing field remains a challenge. The manufacturing skills gap could result in 2.1 million unfilled jobs by 2030, according to Deloitte. Fostering skilled labor is a goal that communities and public-private partnerships should focus on as a geographical differentiator for companies considering site selection. Labor market growth through immigration is also a key consideration; immigrants supply low and high-end skills and have accounted for almost half of labor force growth since the mid-1990s7. A potential outcome from the current geopolitical crisis is an increase in immigration to the United States. More than 3 million Ukrainians have fled their country, and Eastern Europe is dealing with the largest refugee crisis since World War II. To a significantly lesser extent, some Russians, facing crippling sanctions and authoritarian pressure, are also leaving their country. Extended unrest in the larger region may lead to more talent and business relocation. Over 30,000 Ukrainians that were already in the United States prior to March 1st, 2022 were granted temporary federal protection to stay and work legally for 18 months. The number of European refugees the United States can accept is capped at 10,000 for the current fiscal year, but the White House has announced it will work with the United Nations and European partners to determine potential permanent resettlement options, whether in the States or elsewhere. While many factors remain unknown, there may be potential to offer safe harbor as well as expand the national labor market through resettlement of Ukrainian refugees.
1Morning Consult, February 2022 U.S. Consumer Spending Report
2Sources include Bank of America, Kiplinger, Federal Reserve Bank of NY
3Penn Wharton Budget Model
5Jason Miller, MSU Broad College of Business
7Federal Reserve Bank of Dallas
Additional Sources: Newmark Research, The White House, New York Times, Wall Street Journal, FreightWaves