What the war in Ukraine means for private real estate

The conflict has wide-ranging implications for property investment in Europe and the US, and across the capital stack.

Russia’s invasion of Ukraine, with the ensuing economic sanctions against the aggressor and the ripple effects on global markets, has myriad implications for the private real estate industry.

At first glance, the conflict in Ukraine will have little direct impact for most managers and investors. “Real estate portfolios, in particular, have very limited to no direct exposure to assets in Russia or Ukraine,” Taylor Mammen, CEO of RCLCO Fund Advisors (registration or subscription required), a real assets focused consultancy firm, tells affiliate title PERE. “Any implications of the conflict, therefore, will be indirect and based on broader macroeconomic impacts.”

Indeed, outbound real estate capital flows from Russia averaged just $330 million per year in the last five years, while inbound flows averaged $960 million per year over the same period, according to New York-based data provider Real Capital Analytics. Meanwhile, Ukraine recorded an average annual transaction volume of $418 million from 2017 to 2021, the data showed.

However, with the Ukraine crisis, inflation concerns loom even larger for managers that had already been looking at how to navigate an inflationary environment they believed was likely to be short lived. Many real estate investors now believe the inflationary period will be more prolonged because of the conflict.

For example, the disruption arising from the conflict is expected to put further pressure on construction costs as well as additional stress on global supply chains and raw material sources.

Before the invasion of Ukraine, construction costs had already been rising in recent quarters, according to the Turner Building Cost Index. At the end of 2021, the index rose to a value of 1230, registering a 1.91 percent quarterly increase from the third quarter of 2021 and a 5.04 percent increase from the end of 2020.

In response to surging costs, US Federal Reserve chairman Jerome Powell said on Wednesday the central bank is planning a 25 basis point increase to the base interest rate at its meeting in two weeks.

Lender concerns

For lenders in particular, the escalating conflict in Ukraine presents additional considerations atop the existing stressors of inflation and expected interest rate increases.

Jason Hernandez, head of real estate debt, Americas at Nuveen, says the biggest concern is market stability, especially if the ongoing conflict causes a repricing of risk that stymies liquidity for real estate assets. “Some of the rising rates due to inflation can be absorbed by a reduction in relatively wide risk premiums,” he points out. “The geopolitical risk is the bigger issue.”

In a report published last week, the Chicago-based asset manager said market volatility is expected to tick further upward in light of the sanctions imposed on Russia.

“While we do not expect military action to spread beyond the borders of Ukraine, the economic ramifications could be relatively far reaching,” the report said. “Half of Europe’s energy supplies originate in Russia, and Germany has already cancelled a planned pipeline due to the current hostilities.”

Manus Clancy, a senior managing director at New York-based data provider Trepp, says the conflict has so far been more tame for US commercial real estate debt markets compared with previous crises, such as the global financial crisis of 2008 and early days of the covid-19 pandemic. “What we’ve seen thus far is what I’d call ‘an orderly widening of the market’,” Clancy says.

However, securitised lenders have cause for concern because of the potential for substantial spread volatility between the time of a loan’s origination and subsequent securitisation.

“They’re terrified that their hedges won’t hold up and that can happen when spreads go haywire,” Clancy says. “Lending dries up the minute the lenders start to look at losing money.”

Equity fallout

For equity investors, the fallout will continue to drive increased demand for properties with high rental turnover, namely multifamily, industrial and hotels, Jeff Giller, head of real estate at private markets firm Stepstone Group says. Multifamily is likely to be an area of opportunity in Europe, too, as the fallout has led to 160,000 Ukrainians currently displaced, with the EU estimating that number could climb to 7 million. Geographically, investments close to the conflict, for example those in Poland, are likely to carry increased risk for the medium-term.

Indeed, “those economies in central Europe with the closest links to the Russian economy will likely be harder hit from the sanctions regime and this could have knock-on effects for the commercial real estate markets in those locations”, notes Tom Leahy, RCA’s head of EMEA real estate research. Along with a general sense of instability in the region, this means transaction volumes in central Europe may be lower than they would have been had the invasion in Ukraine not occurred.

He also cautioned the war’s potential impact may not be confined to just central Europe: “Clearly, the longer the conflict drags on, the worse the effects will be, not just on neighbouring economies but for stability in Europe in general.”

Nearly all the market participants interviewed described a flight to safety, suggesting the US as a market unlikely to feel any major effects from the war raging almost 6,000 miles east. Many US investors had already retreated from emerging markets because of currency volatility and perceived political risk, says Nancy Lashine, managing partner and co-founder of New York-based placement agent Park Madison Partners. Those concerns are likely to continue, driving more investment to the US from further afield too.

“We expect the chaos in Europe, and the hardening of a Chinese/Russian alliance to increase demand for US assets as a safe haven,” says Nitin Chexal, CEO of Palladius Capital Management.

“The US economy will be the least impacted large open economy due to our domestic energy and food resources,” he adds. “Non-US investors will overweight their equity allocations to US real estate as a result.”