Inflation and the real estate market: the residential, industrial and retail sectors are the most exposed, while the office segment remains the most resilient

Inflation has become a hot topic for the real estate market, as all players in the industry (tenants or investors), are experiencing the effects of rising prices in one way or another, the most exposed sectors to the inflationary pressures being the residential, industrial and retail ones, with a lot more resilience found in the office segment.

However, we estimate that energy price volatility could accelerate the companies’ process of relocating in green, energy-efficient buildings where ESG standards have been implemented.

Bogdan Sergentu, Head of Valuation & Consulting Cushman & Wakefield Echinox: “The economic measures adopted during the pandemic, amplified by the effects of the war in Ukraine and by the sanctions imposed on Russia, have led to a surge of inflation towards unprecedented levels in the recent history of the Western world. The measures adopted by most central banks focus on a progressive increase of the monetary policy rates with the hope of a “safe landing” which would not create too many shocks for the economy. The issue here is that a second set of measures which could stimulate production, and therefore increase the supply, is delayed, with global decision-makers focusing on decreasing the demand.”

The current global real estate market has seen developers struggling due to the lack of construction materials and also due to increasing land acquisition costs, while asset managers have to deal with unstable operating costs, as investors are facing uncertainty regarding financing costs.

Office space occupiers are directly impacted by this current record level of inflation which will lead to increasing occupancy costs, costs which now account for up to 10% of a company’s operating expenses.

It should be noted, however, that the office rental levels are largely determined by the market conditions which means that a rental increase is a phenomenon more related to the local market fundamentals and to the vacancy rates and less related to the inflationary trends.

A very important element for office tenants pertains to the early establishment of the number of required workspaces and thus of the leasing strategies, given the impact of increasing fit-out costs, and also of the changes in the way employees work.

Companies active in the retail market recorded turnover increases given the present inflationary context, a matter which renders the rent stable as a percentage of the turnover. However, the increasing utilities’ costs could not be countered.

Although retail sales have generally increased as a result of rising prices, this trend may change in the near future as buyers become more price sensitive due to the higher costs for gas, food and other essential products. In order to maintain in-store traffic and to maximise the sales conversions, retailers will need to consider the clients’ changing shopping habits and adapt their entire omnichannel strategy to these particular changes. In terms of costs, the increasing operating expenses will significantly reduce the operators’ profitability in this inflationary environment.

The industrial sector has been the best-performing real estate market segment in the last few years, but tenants occupying industrial premises are facing pressures related to the operational, workforce and real estate costs.

However, the inflationary pressure will manifest itself differently on the industrial and logistics market, given that around 3 million sq. m of such spaces are owner-occupied in Romania, in addition to the aproximately 5.6 million sq. m available for lease, with retail chains and automotive companies being the most active ones in this regard.

This means that a higher share of occupiers of industrial and logistics are vulnerable to the market instability compared with other real estate sectors. In fact, the occupiers whose strategy is to acquire or build their own spaces have to deal with an increase pertaining to land prices and construction costs. Moreover, they also have to counter the construction workforce deficit. The unexpected increase of the occupying costs is the main challenge for the tenants in industrial and logistics spaces. All in all, the occupiers of such spaces will be equally affected by the rising inflation, even if in different directions, regardless if they are tenants or if they own the spaces they operate in.

Bogdan Sergentu, Head of Valuation & Consulting Cushman & Wakefield Echinox: “The inflation and the rising interest rates will certainly impact the residential real estate market, a sector strongly linked to loan practices and policies. The decreasing purchasing power can also affect retailers’ sales, and could also lead to a decline of demand for warehouse spaces. We believe that the office sector will be more resilient, as current events can only affect the market if they persist on the medium and long term.”

In a market where the annual inflation rate was of 14.5% in May, a rate fueled by rising prices for electricity, gas and central heating (more than 40% y-o-y), tenants will be more concerned with finding energy-efficient solutions in order to carry out their activities.