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Four points for private real estate to consider amid the Ukraine invasion

Inflation, energy sourcing and debt are among the areas industry practitioners should be monitoring as the conflict between Russia and Ukraine rages on.

It would be remiss of PERE, as a private real estate capital markets publication, to opine over the Ukraine-Russia conflict beyond deploring the loss of life we see reported daily across news channels. But it would also be remiss of us to not point to areas that should impact the operations of market practitioners over the coming months. As the conflict passes the weeklong mark, here are five areas private real estate managers, investors and their advisers should be alive to:

Direct investment: Russia represents a blip in the global commercial real estate market, with outbound capital flows averaging just $330 million per year in the last five years and inbound flows averaging $960 million per year over the same period, according to data provider Real Capital Analytics. The five-year average transaction volume for Ukraine, meanwhile, was just $418 million, the data showed. Minimal direct Russian investment is going to grind to a halt. Houston-based Hines, previously an investor in the country, is one manager to tell PERE this week there will be no future outlays. But what about central Europe? The area has seen a significant institutional investment in commercial property in recent years. Some organizations are, as yet, undeterred. Just this week, Europa Capital announced the launch of a logistics platform targeting the region. Nevertheless, most managers and investors looking at the region are likely to be reassessing their commitments in light of the crisis.

Inflation acceleration: Construction prices were on a meteoric rise even before Russian troops set foot in Ukraine. In the US, for instance, the Bureau of Labor Statistics’ Producer Price Index, which tracks development inputs such as material and transportation costs, was up 29 percent from April 2020 through November 2021. After the invasion and subsequent round of intense sanctions levied against the world’s number three oil producer, crude oil prices skyrocketed north of $110 per barrel for the first time since 2014. Financial penalties include carveouts for energy – for now. But with major oil companies such as BP, Shell and Equinor walking away from assets and business agreements in the country, the price spike is unlikely to be short lived. The exact impact of higher oil prices on construction costs is hard to predict. But additional inflation will have to be factored into development-oriented business plans moving forward.

Lending: A major knock-on effect that could be felt in the near term is the increasing cost of capital. Deployment of capital will become more expensive as risk premiums across asset classes, including real estate, will rise as the spread widens between the risk-free rate – Treasuries in the US; Eurobonds in Europe – and returns, industry observers told PERE this week. As lenders start to worry about losing money amid falling pricing, financing will consequently dry up. The length of the conflict is still unknown, meaning this part of the market could be stalled for a while.

Energy sourcing: Additional inflation will have to factor into underwriting of existing real estate investments, too – especially in Europe, which currently sources about 40 percent of the gas it consumes from Russia. An abrupt cut-off would almost certainly push the region to up its usage of nuclear and, inevitably, coal, reports PERE’s affiliate title Infrastructure Investor, at least in the short term. Such an outcome would force many sustainability agendas back to the drawing board. Moreover, the threat of the withdrawal of Russian gas should push the use of renewable energy sources to better power buildings higher up the agenda.