The U.S. economy is facing significant headwinds, particularly rising inflation, continued supply chain bottlenecks, as well as increased labor and material costs. A recently released report by commercial brokerage firm Cushman & Wakefield focused on inflation’s impact on commercial real estate tenants and what obstacles and opportunities exist for businesses as they fine tune their leasing strategies.

The key takeaways from the report, authored by Cushman & Wakefield’s Rebecca Rockey, economist, global head of economic analysis & forecasting and James Bohnaker, senior economist global research, included:

• A large imbalance between labor supply and demand has led to shortages across sectors, and wage growth is responding. Harder hit sectors like accommodations, food services, retail and wholesale trade—where labor is about half of all operating expenses—are all recording the fastest wage growth rates in the economy.
• Input and operational costs range from materials to costs of energy, transportation, storage and supporting services. Inflation in the supply chain is much more acute than that for services or consumer prices, reflecting special dynamics of the pandemic recovery. Goods prices are rising at more than three times the rate of services prices as a result.
• Real estate costs are largely driven by market conditions—that is, rent growth is a function of local fundamentals and vacancy conditions and less so of national or even local inflation. This creates both opportunities and challenges for occupiers, depending upon the property types they lease.
• However, real estate costs associated with buildouts have risen significantly and labor shortages are compounding challenges for occupiers. Planning further in advance is more important than ever.

The report cited recent Producer Price Index figures for construction materials that detailed the dramatic cost escalations of late. The overall PPI for construction materials at the end of April 2022 was 19.6% as compared to the year before. Compared to February 2020, key materials recorded significant price increases: PVC and plastic piping (129.4%), aluminum (102.7%), iron/steel (88.5%), lumber (49.8%), gypsum (30.8%) and fiberglass (13.8%).

While developers are absorbing these costs, tenants are not immune from escalating costs, the report notes with the PPI indices for furniture, commercial electric lighting and office supplies experiencing increases of 11.8%, 10.2% and 7.2% year-over-year, respectively.

The prospect of rising rents for tenants depends of course on when their lease terms expire and also what type of space they operate out of. Simplistically, the lower the vacancy rate, the likelier the firm could see higher rents. Industrial real estate tenants with expiring leases should take note.

“At present, industrial vacancy is at the lowest point on record (3.3%) whereas office vacancy is at 17.5% and is still likely to trend higher as new supply comes to the market. For retail shopping centers, vacancy held up fairly well during the pandemic and is now below pre-pandemic levels by 10 basis points (at 6.3% in Q1 2022 versus 6.4% in Q4 2019). Not surprisingly then, industrial rents are under the most upward pressure, with retail rents growing but at a more subdued pace,” the report stated. “Office rents are still declining but likely near their trough. Given the tremendous variation by market and property subtype, occupiers should invest substantial effort in understanding these dynamics as they consider location and potential lease decisions.”

To download the full Cushman & Wakefield “How Inflation is Impacting CRE Occupiers, go to: https://www.cushmanwakefield.com/en/united-states/insights/how-inflation-is-impacting-cre-occupiers