What Does The Russian Strategic Collapse Mean For CRE?
MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.
Recent developments in the Ukraine war with Russia have taken a decided turn toward easing global political and economic tensions and stirred others. These events and processes will ultimately impact the relative supplies and performance of global currencies, commodities, and therefore interest rates and, by extension, cap rates and commercial property values.
A Quick Recap
When Russia invaded Ukraine in February of this year, it became clear to observers after the first two weeks that Russian military forces were a struggling minor league team at best. From the 40 KM long single-track military convoy they were forced to abandon on foot to their forced retreat from attempting to take Kiev, it was clear the Russian military was extremely overrated.
They did, and still do, however, have vastly superior numbers of both personnel and hardware units. The US and NATO were very careful to supply the Ukrainians only with short-range weaponry, expertise and intelligence, but not escalation-level strategic-scale weapons that could reach into the Russian heartland. These have proved to be game-changers.
Russian Weaknesses
What the Ukrainians are exploiting expertly are the results of years of corruption in the Russian government and military. Russia needs imports to be able to manufacture ordinance. Under the extreme sanctions it finds itself, this is a non-starter. Manufacturing capacity is all but dead, and we see this expressed in their shopping for hardware from the likes of Iran and North Korea, countries not exactly known for their manufacturing scale or quality.
Money earmarked for such necessities as training personnel and maintaining vehicles and stockpiles has long been stolen. We see this evidenced in Russia’s having to repatriate both hardware and personnel from other theaters, such as Syria, the Caucasus, and Kazakhstan.
New Developments
Although the fog of war is still thick, and we likely won’t have clear color on these developments for weeks, several conclusions are inescapable, even at this early point. The most important of these is that the Russian strategic position in the region, let alone the world, has collapsed as the Ukrainian army has successfully counterattacked in Kherson, Kharkiv, Donetsk, and other locations. Not only have Russian soldiers again fled on foot, but in doing so they have abandoned functional military hardware the Ukrainians need no training to use. In fact, the Ukrainian army has now received more military aid from Russia than from the US in the last 6 months.
Implications
Markets have struggled to digest and reposition in response to Russian aggression, not only militarily, but economically with regard to gas, fertilizer and grain exports. Political pundits of many stripes have extolled the evolution away from a US-led order toward a multi-polar order with Russia and China as key players, and by extension, their currencies as competent challengers to the US dollar’s primacy in the world economy. The intellectual vacancy of these ideas is now on full display. Even Xi Jin Ping has come out of hiding to head to Kazakhstan to wonder aloud how he could have been so wrong as to back such a wrong horse in this race.
Commodity markets have been predicting a softening for weeks. While these developments do not imply Russia won’t successfully counterattack or stand firm, they do suggest few will care. The Russian strategic position has been severely compromised, such that in the eyes of its neighbors and allies, it is militarily incapable of withstanding any confrontation with so much as Moldovan, let alone NATO forces.
Geopolitical Implications
Every Russian ally must now concern itself deeply with its own adversaries, as big brother is no longer there to protect them. The Syrian civil war, for example, takes on a whole new shape, with Israel essentially able to impose its will without Russian opposition. Azerbaijan can wail upon Armenia with impunity. Georgia can again impose its will inside North Ossetia without the fear of another Russian military trap. That’s one aspect.
Another aspect is that countries in the western hemisphere, such as Cuba and Venezuela are now squarely in the cross hairs of the US. If not for the still-sensitive condition of world petroleum markets, the Venezuelan regime would be a prime target for elimination in the coming weeks. Cuba has no support whatsoever at this point, and the US is likely baiting the Chinese to try something there in an effort to get them to do more of the leg work in ending China as a power in any respect.
Economic Implications
From an economic standpoint, markets will likely continue to move toward the reality of a unipolar, US-led world market where all other currencies are second-tier. We see this playing out currently in the Federal Reserve’s ability to raise rates by 75 basis points at a time with markets pricing a 15% chance of a 100 basis point hike this month, without cratering the US economy. This hike cycle doesn’t seem to bite like previous cycles, likely because the ‘inflation’ these hikes are supposedly calibrated to combat is industrially-driven, not consumption-driven. Economic growth should, therefore, remain robust as the world is able to unclench from the acute and knock-on effects of foreign wars.
Commercial Real Estate Implications
The political and economic forces that were present before the Ukraine invasion, namely inflation, accelerating US economic growth and supply disruptions, should now begin to attract new drivers. If global investors thought US dollar-denominated assets were attractive during war and uncertainty, they should be delighted to take the gloves off and coal shovel capital into dollar assets in a more certain environment where the two putative challengers have not been decimated, per se, but have decimated themselves and beheld the emperor’s lack of clothes for the world to see. Interest rates will continue to rise on dollar assets, including commercial real estate; however, once the market adjusts to the new environment and deals are able to pencil out at higher cap rates, the line for the entrance should once again crowd the CRE investment space.
Conclusion
Russian power has taken a serious strategic blow, and this will exert itself in the coming months in the realms of geopolitics, economics and asset prices. US commercial real estate, as the second largest asset class in the world (second to Forex), should benefit from more robust activity irrespective of rates, as uncertainty unwinds in the coming days and weeks. Russia’s strategic position collapsing changes things considerably, and at the risk of getting out over our skis, that’s really how you ski steep terrain. Industrial property, particularly, should begin to really shine in short order.
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