INFLATION

Inflation

According to the Federal Reserve Bank (FRB), annual inflation, as measured by the Consumer Price Index (CPI) registered at 6.4% as of December 2022.

In the 20 years prior to the pandemic, the CPI averaged 2.2% annually on any given month. Keep in mind that these averages include the substantial downturn periods of the Great Financial Crisis (2008 – 2010) and the early months of the pandemic. But overall, inflation in the US was in its lowest long-term period in recorded history.

Then came CoVid, shutdowns, massive stimulus, supply chain disruptions, and then an invasion that threatened global energy supply lines. In other words, a perfect cocktail for sending inflation through the roof very quickly. While initial increases were driven by Americans with more retail spending power (demand), combined with a CoVid-overwhelmed (especially for Chinese imported goods) supply chain. Reduced domestic oil production had already exasperated energy pricing by late 2021 as Americans returned to the road. US oil production had peaked at 13 million barrels per day in November 2019, but fell as low as 9.7 million barrels a day by May 2020. By the time that Russia sent global energy markets

Gas Prices Coming Back to Earth

Inflation Has Peaked Interest Rate Hikes Showing Impact

into turmoil with its invasion of Ukraine in February 2022, US oil production was still down 13.1% from peak.By June 2022, year-over-year price inflation peaked at 9.0%. This was the highest rate of inflation since the early 1980s and prompted the aggressive action of the Federal Reserve in raising interest rates to slow the economy.

As of December 2022, the overall CPI rate had fallen to 6.4%. It is anticipated to continue to decline, but this relies immensely upon further moves of the Fed in addition to global political and economic events. We anticipate, barring any unforeseen “black swan” events that the downward trend in inflation will continue but that it is not likely to fall below the 4.0% annual rate by year end unless a dire economic situation unfolds. Luckily, we do not anticipate the latter either.

Gas Prices Coming Back To Earth

The current wave of inflation is global. Its initial roots were in the massive amount of government stimulus that Central Banks across the world unleashed to prevent a depression in the wake of the CoVid-19 crisis. In the US, this amounted to $7 trillion in stimulus; approximately $3 trillion in Treasury bond purchases to stabilize the stock market and an additional $4 trillion in direct aid to businesses and individuals. By comparison, adjusted for inflation the US spent roughly $5.5 trillion on World War II.

While moves like this across the world had the intended effect of stabilizing economies, the impact of massive amounts of money being pumped into the global

GAS PRICES COMING BACK TO EARTH CONT.

economy was bound to have a major impact on equilibrium between supply and demand. Too much money suddenly chasing the same (or reduced) amount of goods, services, or assets available is a surefire recipe for rapid price acceleration.

The exposure of the fragility of global supply chains in an international crisis is another that started to drive inflationary pressures by 2001. The Chinese zero tolerance policy for CoVid until 2023 meant the world’s largest manufacturing economy has been prone to shutdowns, output reductions and shipping issues at a time in which US demand for goods climbed.

But the greatest factor driving inflation recently has been the impact of Russia’s invasion of Ukraine. After the US and Saudi Arabia, Russia is the third largest oil producer and accounted for 11% of the world’s supply in 2021. After the US, it is the second largest producer of natural gas on earth. The February 2022 invasion sent energy pricing skyward globally.

The national average price of a gallon of gasoline in February 2020 was $2.47 per gallon. The pandemic crashed the market, with this metric falling to just $1.77 per gallon by late April 2020—lows not recorded since the darkest days of the Great Financial Crisis.

Cost of Construction Materials Also Moderating

Pricing began to accelerate aggressively with the lifting of lockdowns, as oil producers looked to make up for lost time and revenue. On the eve of the Ukrainian invasion the average price per gallon stood at $3.53, up a whopping 43.1% over the pre-pandemic price. With the war, price acceleration would explode further, hitting a peak of $5.01 per gallon in June of last year—more than double the prepandemic price.

Since then, oil and gas prices have been coming back to earth. As of January 16, 2023, the national average stood at $3.31 per gallon, or 1.1% below where pricing was one year earlier.

Construction Costs Moderating

One of the most challenging issues facing the real estate industry over the past two years has been the run up in the price of construction materials. According to the FRB’s data, pricing began to ramp up in September 2020. Pricing climbed 35.1% in 2021. The highwater mark came in May 2022 when pricing stood at 50.1% above pre-pandemic (February 2020) levels. Keep in mind that in the 20-year period before the pandemic, construction costs averaged price growth of 2.8% per year.

The good news is that pricing has been steadily coming back to earth since. But as of December 2022, they still stood at 39.4% above where pricing was before the CoVid crisis.

This has been a major factor in slowing residential development over the past two years, even when the housing market was experiencing an unprecedented boom between late 2020 and early 2022. It also has had major impacts for ongoing commercial development, redevelopment, and tenant build-outs—particularly for industrial and multifamily projects, which have been driving commercial real estate development over the past few years. If these elevated construction costs cannot be passed on by developers in pricing or rents, potential profitability is challenged and development levels will be hampered.