A looming trade war could have implications for investors, developers
INSIGHT ARTICLE |
Over the last few months, the Trump administration has imposed tariffs on several foreign goods. The tariffs include steel and aluminum taxes imposed on Canada, Mexico and the EU and a proposed $200 billion levy on Chinese goods, with several additional tariffs still being finalized.
These tariffs are expected to affect a number of industries, with commercial real estate taking a substantial hit. Increased construction costs, coupled with the tariffs’ impact on foreign investment, could turn the commercial real estate on its head. As countries like China respond to U.S. levies with retaliatory tariffs, uncertainty around a looming trade war has prompted several investors and developers to back out of deals or prevent them from moving forward. Commercial real estate professionals across all asset classes are preparing to see an economic impact.
The cost of tariffs
Nearly 10 years after the recession, the commercial real estate industry is seeing a surge in construction across the United States. Since 2012, homebuilders have doubled housing starts, and developers have added 138 million square feet of office space.
Tariffs pose a threat to this progress. The 25 percent tariff on foreign steel, a material that generally accounts for an average of 14 percent of a building’s cost, is expected to limit development in office, retail, industrial and multifamily construction.
The construction industry has also felt the impact of a 21 percent tariff on Canadian lumber, which was enacted back in 2017. Lumber accounts for 9 percent of total construction costs, but these tariffs, coupled with an overall reduction in supply, have led to a 36 percent increase in lumber costs over the last year.
When you look at the cost of steel and lumber, they have been up from a commodity standpoint from 15 percent to 20 percent year over year, which translates to a 9 percent or 10 percent increase in the cost of a project, depending on project size.
The labor market has also had a significant impact on pricing. Contractors and subcontractors are charging more because of a lack of talent. They have a number of jobs to bid on, and they can continue to charge more for each job.
A broad-reaching impact
Whether or not the tariffs will affect a specific development or region is dependent on a number of factors. For instance, location plays a large role in the level of impact. These tariffs could press pause on construction in overdeveloped areas, but worsen supply shortages in other areas.
If you look at some of the coastal cities such as New York, they have had some issues with the oversupply of multifamily space. With rising costs of tariffs and the labor shortage, we're projecting in 2019 there’s going to be some slowdown of new supply coming to the market, which will help bolster rent growth in those areas, which is the type of market where existing owners will benefit from a potential slowdown in development. On the other hand, underdeveloped areas, especially in more rural areas, could be hit especially hard by the tariffs.
To invest or not to invest?
Tariffs have driven many investors to think twice about the projects they fund. As tension arises over the impact of these tariffs, a number of projects are not getting the funding they need to deliver.
Many businesses are delaying capital investment, and development margins are slim, so project success has a lot to do with appropriately timing the market. You do not want to be caught in a situation where you are ready to deliver your asset and you find yourself in another recession. It is that overall uncertainty in the short term that is influencing the true economic impact over the long term.
A looming trade war
Other investors are looking to diversify their portfolios, but want to make sure they will not be hit with costs before they commit.
We are having a lot of clients that are looking to diversify into ground-up development and rehab for older properties, and moving into that space where they don’t have a track record there. We are advising them to look at contracts and make sure there are clearly defined clauses that account for commodity price and supplies, and material price increases that could be tariff-driven. Mitigating legalities and the impact of the tariffs is where we are advising our clients.
Another concern, especially for large developments in major cities like Chicago and New York, is the divestment of Chinese capital. Foreign direct investment dropped by 92 percent year-over-year in the first half of 2018, Foreign Policy reported. It is part of an effort on behalf of the Chinese government to keep investment from leaving the country.
This divestment started even before the trade war escalated. Meanwhile, the United States has also cracked down on Chinese involvement from a national security standpoint, and I anticipate more scrutiny there as well.
In the meantime, investors from Canada, Germany and South Korea have helped offset the exodus of Chinese investment in commercial real estate. If they pull out because of the tariffs, commercial real estate activity could see a slowdown.
As the trade war continues to evolve, policy experts expect there to be further changes and new announcements regarding tariffs over the next few months. By staying informed about changes in the market and keeping an eye on breaking news on the trade war, investors and developers are preparing for impact.
This article was first published Sept. 22, 2018 in Bisnow.
The real estate regional impact reports feature insights from top-level investment experts focused on the different real estate markets.
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