Regardless of your sentiments towards the ongoing trade disputes of United States President Trump, everyone can agree that one thing is certain: uncertainty! Recent minutes from the Federal Reserve meeting reflect the agreement among economic experts that a full round of trade wars will trigger a slowdown of the U.S. economy in the coming years. The extent of the impact may be up for debate, depending on the severity of the disputes, but a slowdown seems inevitable.
Commercial Real Estate will feel the pinch first and likely feel it harder than other industries due to our direct tie to building materials imported from target countries. These price adjustments have been significant already: a 25% increase on steel (China), a 10% increase on aluminum (China), and a 15% increase on wood (Canada), to name a few. But while significant, they are only one-time price adjustments—a bump in the road.
“I liken any unexpected shock to an economic structure to be like a large boulder thrown into the river,” said Ginger Bryant, Chief Operating Officer and Chief Financial Officer of Sares Regis Group of Northern California, and a CREW San Francisco and CREW Seattle member. “Water backs up behind it, a little eddy forms, maybe some bits are caught in the whirlpool, but in the end, the water continues forward. It finds a way around. Creative solutions are developed, and business continues as usual. We, like others, are finding new solutions: modular elements, and glulam where steel may have been used previously. Some deals will stall or fall apart, and land residuals will be impacted, but in the meantime, it’s time to get creative.“
Cost and Wage Increases
Material price increases are just one piece of this multifaceted puzzle. Earlier this year, general contractor Mortenson predicted an increase in construction costs capped at 4%, and just six months later, their figure has doubled to 8%. This puts the Mortenson Construction Cost Index at its highest level since it was first started nine years ago.
Naturally, the trade disputes and material cost increases have factored into this historic rate of inflation. However, it is labor costs that have been steadily squeezing margins for development for many years. Wage increases recently implemented by the current U.S. administration indicate that this level of inflation will continue, if not escalate, in the quarters to come. High-cost urban areas such as San Francisco and Seattle have been burdened with the mismatch between a steady supply of low wage workers and increasingly higher cost of living, creating a scarcity of qualified labor. The Fed shows no signs of slowing their steady climb of interest rates as the economy, on the whole, rushes forward. Meanwhile, the U.S. stock market remains unphased.
Will Canada join the proposed new NAFTA trade agreement? Will China retaliate by withdrawing approval for future investment? Amber Schiada, Senior Vice President, Director of Research at JLL and a CREW-LA member, believes that these factors (higher cost of money, higher material prices, rising labor costs) taken together will have a cumulative effect. Construction prices will continue to increase, taking housing prices with them. Demand will ultimately loosen, and the market will start to soften.
“It’s just math,” Schiada said. “Less commercial development is the natural result. Projects in the works will continue to move forward, but borderline projects are more likely be abandoned. Fewer projects will be started, especially larger high-rise developments with long entitlement battles ahead. Developers are likely to step back, preferring to wait while uncertainties settle and politics calm down. Foreign investment has already started to slow.”
The industrial markets are likely to continue to be strong. Schiada, who oversees work in Los Angeles, reports that the Los Angeles Port is busier than ever, continuing to have record number of imports and showing no decrease in volume yet.
On the West Coast, e-commerce fuels much of the demand for industrial space. Cushman & Wakefield’s Inland Empire Industrial Market Beat reports extraordinary low vacancy rates of 4% with no immediate signs of change. (Inland Empire is defined as the cities of western Riverside County and the cities of southwestern San Bernardino County; adjacent to the Los Angeles metropolitan area.) Other markets share similar stories. Industrial buildings tend to be simple shells, so construction costs are low and labor costs less, tipping the balance of the margins in their favor. The persistent growth in this sector is not likely to be impacted in the same way that office and residential markets will be.
"It would have to be a pretty massive trade war for it to impact industrial real estate directly," said Rene Circ, director of U.S. industrial research for CoStar, adding the caveat that ultimately anything that impacts the entire economy would certainly affect industrial real estate. "A no-growth economy hurts everyone.”
A Different Perspective
At a recent tour of the newly completed Salesforce Tower, from the uppermost floor, I peered down at the city of San Francisco spread out below me. It was not the rolling hills, iconic TransAmerica building or even the Golden Gate Bridge that caught my attention. Rather, it was the seemingly endless stream of large black and orange cargo ships etching foamy lines across this sparkling turquoise expanse of the San Francisco Bay. Eight ships made their way through the Bay, soon to end their long journey across the Pacific.
From this perspective, the Bay could be seen as the watery thoroughfare of international merchandise and materials—a continuous exchange of goods slithering across borders, interweaving economies in their wake. The latest trend in shipping container architecture is a testament to the massive imbalance between import and export. The documentary Freightened provides an in-depth look at the impact of the international reliance on transportation via tankers.
With a U.S. trade deficit higher than that of 150 of the 180 countries of the world, we are running a deficit of more than 3% percent of the U.S. GDP. Does it matter? Is it the boulder in the river or a change of the tides in a vast ocean that connects continents? There is more than one side to that story.
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Donna Schumacher is Founder and Creative Director of Donna Schumacher Architecture. DSA is a boutique architecture firm specializing in one-of-a-kind signature interiors and design elements. Schumacher has led dozens of successful projects during her 30 year career, including Stearns Political Consulting Offices, the San Francisco Arts Commission Gallery and SFCameraworks. Schumacher has contributed numerous articles for art and architecture publications, most recently as the Founding Editor of the VIEW, a quarterly newsletter for CREW San Francisco. She is a member of the CREW Network Communications and Editorial Committee.