The Russian invasion of Ukraine sent shockwaves across the world and propelled markets into deep uncertainty. The conflict is ongoing with no end in sight yet. The visceral international reaction toward the invasion and the subsequent imposition of sanctions have made the situation even more volatile.
The war displaced millions of Ukrainians, leaving the Ukrainian economy in shambles. The impact of war beyond the borders of Ukraine is just beginning to show. The question is - how will the war in Ukraine affect the commercial real estate market in Orange County, located halfway across the globe? Let’s look at a few important aspects that need to be considered. In the first part of this article, we’ll look at overall economic impacts; in the second half, we’ll evaluate exactly how the war will impact Orange County real estate.
How the War Can Impact Commercial Property Transactions
A war between two countries that are well-integrated into the global economy entails an impact on the economy that will be felt worldwide. The two key ways in which the war will influence industries across the country are market volatility and inflation.
Global financial markets have been on edge for the last few months due to the persisting war. Market indices have been upbeat with increases in activity post-pandemic; however, the war has caused investors to be more careful of what and where they invest.
Most of the market volatility derives from hesitant investors who are uncertain about the extent of the impact. Conflicting reports and variable opinions from news outlets also generate uncertainty, which only adds to the volatility. As such, many investors are waiting to see how the sanctions play out and what second-order impact the war will have.
While investments in Russia and Ukraine are uncommon among US investors, other European markets remain accessible and therefore, vulnerable. The European economy is more likely to be greatly affected by the war given Europe’s dependency on Russian oil and gas.
The volatility is causing businesses and investors to be more cautious when looking at investment opportunities in all domains including real estate, as they are also recovering from the lingering effects of the pandemic.
Inflation is the critical aspect that will influence the real estate market the most. Supply chain issues and a reduced labor force resulting from the pandemic have pushed inflation higher, along with the fuel and energy price hikes. Regrettably, the war has only been aggravating the situation.
Inflation is already starting to impact many aspects of life today. The February 2022 Consumer Price Index stated that prices rose by 7.9% in February, compared to the previous year. This is the largest annual growth in prices since 1982.
There have been predictions about interest rate hikes in the coming months to control the inflationary pressure. The risk of stagflation has also been a concern among many leading voices in economics.
In an ideal world, high inflation makes it the best time to borrow. Interest rates are currently low and over the coming months when the Federal Reserve rolls out measures to control inflation, the interest rate will spike, making loans more expensive.
This is good news for commercial real estate as more investors are looking to borrow now and invest in properties. This is likely to boost sales activity in California as well as in the US real estate market.
It is also worth noting that there has been little respite for the supply chain problems caused by the pandemic. Global supply networks have been inundated amidst the shipping crisis and COVID-induced restrictions, leading to a drop in production. Rising fuel prices and economic sanctions will only serve to exacerbate supply chains further.
How Will All This Impact the Orange County and CA Commercial Real Estate Market?
It’s impossible to know the eventual impact that the war will have on the economy but observing the changes in inflation and fuel prices in real-time gives insight into how these changes reflect on the Orange County market.
Location is Going to be Important
Many businesses are currently operating in a fully remote or a hybrid mode while most are fully opening their offices again. Those who are on the lookout for new office spaces and investors looking to buy commercial real estate will be wary about the location of the property. Employees prefer to minimize their commute due to both the cost and time of travel. As a result, real estate properties that are central to residential areas will see a higher demand.
Areas like Newport Beach, Irvine Airport Area, and the Irvine Spectrum, which are home to large numbers of 4-star and 5-star office properties will certainly maintain their popularity, however, we believe that other cities within Orange County such as Anaheim and Santa Ana will see a spike in office demand as they are more centrally located and more accessible from other cities.
Rental Rate Hike and Price Hike
The most significant consequence of inflation will be reflected by the growing rent prices and the cost of commercial property. Depending on the property type and the demand, the cost involved in constructing and maintaining the property will rise. The supply chain shock and rising fuel prices will certainly increase costs for renovating or constructing any properties.
Another consequence may be evident in cuts to spending on property management and facilities, as landlords try to adjust to the impending changes. Currently, these are important perks presented to businesses to attract them to leasing. But the rising cost of management can induce landlords to cut back on these additional expenses.
Tenants may also have to spend more if they are leasing a new office, retail, or industrial space. Those looking to renovate their spaces before moving in will have to account for the rising costs and consequently, may not be able to lease as much space as they initially planned.
The price hike is certain to affect properties currently under renovation by possibly slowing down construction.
The sale activity for real estate had been picking up over the last year with 12 monthly sales volumes of $2.7 billion which is close to the $2.5 billion per year 5 year average. [A2] This figure is in spite of the fall in the number of transactions. The inflationary pressures and volatility are likely to cause these numbers to stagnate.
While commercial real estate activity is still recovering from the effects of the pandemic, the war in Ukraine has now complicated recovery. Investors remain wary of inflation and market volatility in addition to remaining watchful for signs that the economy may be trending towards stagflation.
In comparison, growth in the domestic market and increased activity indicate that more businesses are also looking to expand and grow. The war has made the US a safe and attractive proposition for investors, likely increasing investment in real estate properties.
Although the full impact of the war in Ukraine cannot be accurately determined now, signs show that rent and property prices will be on the rise, especially in high-demand areas. Businesses however will remain wary of signing long-term high-rental deals which could impact the real estate market in the long run.