Law360 (April 1, 2022, 10:58 AM EDT) — As Russia’s invasion of Ukraine enters its second month, U.S. real estate investors are all eyes on supply chain and inflation concerns, while global investors could shift more of their assets into U.S. properties amid growing concerns about the European market.
The U.S. real estate market was already facing supply chain and inflation pressures before Russia’s invasion of Ukraine in late February, but experts say the war has exacerbated those problems and has thrown an additional wrench into the equation, with energy prices now facing additional pressure.
And while U.S. projects are facing severe delays, the U.S. could see additional capital from overseas investors who are skittish about the Europe market.
Here, Law360 looks at three areas of U.S. real estate to watch.
Supply Chain Issues Have Worsened
Chief among the concerns of developers is the difficulty in getting materials, both basic and specialty, to finish projects on time, and that’s leading to a host of delays and cost increases.
“The supply chain issues still remain at woeful levels, and the war in Ukraine has only made things worse,” said Keith Poliakoff of Government Law Group. “My clients still cannot get the materials necessary for construction, which is holding up the amount of new projects, especially residential units, coming to the markets. Developers are experiencing tremendous cost hikes and supply chain issues and fuel cost increases.”
The supply chain issue is just one of a complex set of global concerns that have worsened since the start of the conflict, such as inflation and fear of a recession.
“The war clearly has exacerbated some of the concerns,” said Seth Weissman, a partner at Jeffer Mangels Butler & Mitchell LLP. “If we head into a recession, overall growth goes down and arguably the availability of people to invest in real estate goes down. But at the same time, you’ve got the issue of inflation. … So it could be the worst of both worlds.”
“If we don’t see an oil shock, that could help to stem some of the concerns,” Weissman added.
And while parties are adjusting their timelines to work with the current supply chain bottlenecks, it might not be enough.
“Supply chain issues are likely to get even worse,” said Robert Ivanhoe, vice chair of Greenberg Traurig LLP. “It’s certainly adding a lot of risk and cost.”
Underwriting Has Changed
While developers are adjusting their timelines when it comes to supply chain concerns, parties are now also changing their underwriting to take into account lower expectations for growth, as well as higher prices.
“When clients underwrite real estate transactions, they have an expectation of return. Those expectations are significantly impaired when the cost of capital goes up. I’m seeing it already,” Weissman said. “I’m seeing people who are looking at deals who wished they had locked in rates 30 days ago. There’s transactional pressure on the professionals to get deals done.”
While companies are redoing their underwriting when it comes to would-be deals, there’s also increased pressure on the rental market. Amid rising prices, owners are forced to either take a financial hit, pass the additional costs onto tenants or some mix of the two.
“It will affect energy prices. … It will affect rents,” Andrew Raines, a founding partner of Raines Feldman LLP, said of the war in Ukraine.
And when it comes to construction, companies are also having to start with a clean slate. In some cases, projects that haven’t gotten off the ground now no longer make financial sense, experts say.
“All of [the developers] have been diligently recalculating the entire cost of the project,” Poliakoff said. “Some of them will not break ground.”
Global Investors Are Eyeing U.S. Real Estate
The U.S. real estate market has long been viewed as a safe haven for foreign investors amid global political and economic upheaval, and the war in Ukraine could make U.S. assets even more attractive to foreign investors.
“Many global investors have always put a significant portion of their investment into Europe. … The perception now seems to be that Europe is much more of a risk to inflation pressures and energy pressures, and that that’s really going to ripple through to real estate,” Ivanhoe said.
There are concerns about the future of the European real estate market, and inflation remains problematic. On the latter point, global investors could look to put more of their capital in U.S. real estate, given that the sector has historically been viewed as a safe haven when it comes to inflationary environments, Ivanhoe said.
“We would hope that as Europe is in a state of flux, that more funds will funnel into the U.S.,” Poliakoff said.
And with the expectation that the European real estate market may get worse, look for more investors to make deals in the U.S.
“People are expecting Europe to become more severe. There’s been more of a focus here as being a safer market. The dollar has strengthened relative to the euro,” Ivanhoe said. “I’ve been getting a number of inquiries from foreign investors who really haven’t invested here before. A lot of them have invested very heavily in Europe. They’re very concerned about Europe right now.”
–Editing by Nicole Bleier and Alyssa Miller.