Tariffs at the Door: How Trade Policy Could Influence Local Real Estate

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The historically high tariffs proposed by the current administration have surprised many in the business and investor community and prompted turbulent market reactions. The S&P 500 lost about 10 percent in the week following April 2^nd before strongly regaining ground on the news of tariff suspension; expectations about interest rate cuts at the next Federal Reserve meeting keep swinging as headlines update rapidly.

These developments and their associated uncertainty could significantly alter economic activity across the United States. Real estate professionals—from developers to investors—may need to re-evaluate underwriting assumptions and growth expectations.

Tariffs influence both the supply and the demand for space among businesses and households. A closer look at these impacts can shed light on how changes in trade policy might reshape real estate markets in local economies.

1. Tariffs slow down supply growth through higher costs and uncertainty.

Tariffs on materials such as steel, aluminum, and other construction inputs can raise construction and renovation expenses, as discussed in detail on Urban Land Online. Projects that made sense at particular prices or projected rents may be scaled back if construction costs rise.

Uncertainty about future tariffs can also constrain supply. When uncertainty grows, the “value of waiting” is higher since executing an investment eliminates the option to act later with more information; in practical terms, this leads to delayed launches of otherwise feasible projects. The index of economic policy uncertainty, a gauge of the uncertainty in the economy, stands at a level only surpassed briefly during the early stages of the COVID-19 pandemic; the subcategory related to trade policy uncertainty is at an all-time high.

Both mechanisms slow down the pace of new supply, which can support—everything else being equal—higher rents. Of course, everything else is not equal since tariffs also impact the demand for space.

2. Tariffs can restrain businesses’ demand for space.

Tariffs directly increase the cost of imported intermediate inputs. For example, according to the OECD Inter-country input-output tables, U.S. electrical equipment producers purchased about 20 percent of their intermediate inputs from abroad in 2019. Empirical evidence suggests that, for many sectors, higher tariffs translate almost one-for-one into higher import prices, pushing up overall production costs. These costs quickly ripple through the supply chain: the same producers of electrical equipment spend 7 percent on other, now more expensive, US-based output of electrical equipment; more generally, they also use other U.S.-based production, similarly impacted by the policy.

This web of reactions ultimately increases the unit costs for producers of goods and services that varies across cities with their overall exposure to international trade. The broad geographical scope of proposed tariffs may limit the ability of firms to seek alternative global sourcing options. Since higher costs generally translate into higher prices, production and input demand, including the demand for space, also fall. Tariffs do have the effect of sheltering some U.S. producers from import competition. These firms might see an expansion in the labor, materials, and space demand—but even they might face higher costs if their supply chains rely on imports.

3. Tariffs have multiple impacts on households.

Households feel the impact of tariffs through higher prices, wage (or unemployment) adjustments, and shifts in overall wealth. First, as already noted, prices of U.S.-based output of goods and services can increase via higher costs along the supply chain. Second, tariffs on final imported goods are also directly, though partially, translated into higher shelf prices.

A study of the trade war with China in 2018 suggests that a 10 percent higher import tariff increases the prices of those goods by about 0.35 percent within a year to 18 months. The surprisingly low adjustment could be explained by the fact that retailers front-loaded some imports at lower tariff levels, shifted to imports from other countries, and, importantly, absorbed this cost increase via lower margins. At the time of writing, the current tariff suspension might offer some opportunities to raise inventories; however, given their breadth, the second margin of adjustment appears less viable.

As firms face higher costs and increase prices, the demand for their products and services will tend to fall, thus leading to fewer workers needed and weakening the local labor market. On the flip side, firms protected by tariffs might increase hiring and wages if they see a bump in demand; yet even these workers would see their purchasing power dented by higher overall prices. These wage effects vary by region depending on the local sectoral composition.

The stock market selloff has been front-and-center in the news. Some evidence shows that higher stock valuations can drive higher local consumer spending, payroll growth in “non-tradeable” sectors like retail or restaurants, and increased residential construction. In particular, an increase of 10 percent in stock market value can lead to around 0.8-0.9 percent increase in total payments to labor two years after the shock. The drop in stock market value has been of roughly comparable absolute magnitude. To the extent that this mechanism works in reverse, one might expect a corresponding drag on local spending and labor income if tariffs are ultimately implemented.

As they translate into lower purchasing power, these effects might impact both the demand for local retail and hospitality services and the demand for apartment space.

4. The consequences for local real estate markets: commonalities and differences

These considerations point to slower supply and demand for space in many locations. There, one would expect a lower overall use of space with uncertain effects on rents: a stronger demand contraction, for example, will produce lower rents relative to pre-trade war conditions. Where tariffs protect local firms, the supply slowdown and the increase in demand suggest an increase in rents, again relative to pre-trade war conditions.

These considerations also suggest some nuances across asset classes. As argued, at least initially, retailers appear to absorb higher import prices via lower margins. If trade pressures persist, and to the extent local consumers face higher prices and lower wages, one might expect downward pressure on retail rents. These pressures might be stronger where household spending is more sensitive to stock market fluctuations.

Office rents, already battered by slow returns post-pandemic in some cities, could be exposed to the consequences of higher input costs as their activity incorporates—more or less directly—internationally traded inputs. Also, a local economic slowdown affecting sectors that most use offices, like business and professional services, might induce some firms to reduce space demand by encouraging remote work.

Demand for industrial space, and thus rents, could rise relative to pre-tariff conditions in areas with import-competing sectors shielded by tariffs. However, even businesses in those industries will face higher input costs, thus benefitting only partially by those measures. Demand for industrial space might fall in other locations, and special attention needs to be paid to retaliatory tariffs that tend to hit particular exporters.

The demand for apartment space depends partly on local income and employment levels. Places that rely on sectors heavily dependent on imported inputs and those more impacted by shifts in wealth may then see a lower appetite for high rents; localities hosting businesses protected by tariffs might see the opposite effect, although tempered by the reduced purchasing power that higher prices might imply. Hospitality services, as a discretionary expenditure influenced by consumers’ wealth and purchasing power, might move in similar directions depending on the typical origin of their customers.

Recent events show that trade policy developments can be swift and unpredictable. This discussion argues that tariffs can impact both the supply and the demand of space in complex ways. A careful understanding of local exposure to all these dynamics is essential in making informed assumptions about underwriting, new developments, acquisitions, and leasing strategies.