The commercial real estate market may be headed downward from growing concerns of a US-China trade war, interest rates and market volatility.
Design contracts, a key indicator of commercial real estate construction and development, fell into negative territory for the first time in almost a year in July, according to data reported by the American Institute of Architecture.
“A growing number of architecture firms are reporting that the ongoing volatility in the trade situation, the stock market, and interest rates are causing some of their clients to proceed more cautiously on current projects,” the AIA’s chief economist Kermit Baker told CNBC.
Architecture billings were most robust in the multifamily sector last month, as demand for rental apartments remains high amid weak affordability in the for-sale housing market. All other areas are in negative territory.
“The data is not the same as what we saw leading up to the last economic downturn but the continued, slowing across the board will undoubtedly impact architecture firms and the broader construction industry in the coming months,” Baker said.
While the relationship between tariffs and commercial real estate is not always immediately apparent, there are several ways in which the ongoing trade war with China is impacting the commercial real estate sector.
Rising Material Costs
Global steel and aluminum import tariffs increased the price of steel products by nearly 9% last year, pushing up costs for steel users by $5.6 billion, according to a study by the Peterson Institute for International Economics. The new tariffs have hit all importers of steel, causing a spike in construction prices- with prices for eleven out of twelve construction components increasing for the 34th time this August according to data released by IHS Markit and the Procurement Executives Group (PEG).
Survey respondents reported price increases in ready-mix concrete, wire and cable, alloy steel pipe and fabricated structural steel prices. The July Index saw a similar pattern, with nearly all components reporting an increase. As more trade tariffs are imposed, it will become more costly to build, which will negatively impact the start of new construction projects.
While the steady rise in material costs has impacted budgets for construction projects, it’s important to note that less than 2% of Chinese steel exports are to the United States. According to the U.S. Department of Commerce, the countries hardest-hit by the tariffs will be EU nations, the U.K. and Germany, South Korea, Brazil, Japan, Taiwan, Turkey and Russia.
Canada, which exports more steel to the U.S. than any other nation and Mexico, which is among the top ten sources of foreign steel are exempt from the tariffs for the time being. However, some experts say it’s not just the impact of rising material costs but also the increased duration of CRE projects, which is causing costs to climb.
In the multifamily sector, experts cite an average delay of around five months for projects that usually take about two years to complete primarily due to the tight labor market and longer lead times for materials. Because the delays increase overall risks, there’s been a significant decline in new CRE starts despite a strong economy and low-interest rates.
New projects may be prevented from taking off or be abandoned entirely, according to economist Walter Kemmsies, Managing Director and Chief Strategist of the U.S. ports, airports and global infrastructure group at real estate services firm JLL.
“Commercial real estate operates on yields, so projects planned may not pencil [out] depending on potential increases in material costs,” Kemmsies said in an interview with NREI. “Folks will postpone projects and recalculate costs. Projects close to the border, or exceeding a minimum required return, may be delayed or canceled. The urgent deals will go through, maybe even regardless of tariffs, but borderline projects could be abandoned.”