A surge in producer prices is rippling through the economy, but for commercial real estate executives, the more interesting story is what did not spike.
Despite a hotter-than-expected jump in the Producer Price Index in May—driven largely by energy costs tied to geopolitical tensions—construction pricing, a critical variable for CRE underwriting, showed only modest movement. That divergence is shaping a nuanced environment where inflation headlines look alarming, but project-level economics tell a more complicated story.
The headline PPI rose 1.1% month-over-month in May, well above the 0.7% increase economists polled by Dow Jones had expected. Core PPI, which excludes food, energy and trade services, climbed 0.8%, double the projected 0.4% and up from 0.5% in April.
Annually, the numbers were even more striking. The PPI for final demand increased 6.5% over the 12 months ending in May, compared to 5.7% in April—the largest year-over-year gain since November 2022. Core PPI rose 5.1% over the same period, up from 4.4% in April and marking its highest annual increase since October 2022.
Much of the surge was concentrated in goods, particularly energy. Nearly 80% of May's increase in final demand prices was driven by a 2.8% rise in goods, while services increased just 0.3%. Within goods, energy prices jumped 10.7% month-over-month, largely tied to the war in Iran. Gasoline alone accounted for more than half of the increase, surging 23.4%.
Strip out food and energy, however, and the picture looks more controlled. Prices for final-demand goods, excluding volatile categories, rose 0.8%, while food prices increased 0.6%.
For CRE, the implications are far from straightforward.
"I don't think the rise in energy cost has an immediate or direct impact on investment decisions," Danny Fishman, CEO of GAIA Real Estate, which focuses on institutional multifamily and residential investing, tells GlobeSt.com. "Most of us see this rise as temporary."
Instead, Fishman points to a more persistent pressure point. "What can have a larger effect on the decision is construction costs," he added. "Right now, most multifamily does not pencil out unless it is for luxury, and the same thing goes for condos."
That dynamic is already evident in development pipelines, particularly in housing, where elevated costs continue to narrow the range of feasible projects. At the same time, other sectors are telling a different story. Retail, for example, has seen limited new construction even as demand for space remains strong.
What stands out in the latest data is that construction-related costs did not accelerate alongside the broader PPI spike. Final demand construction rose just 0.2% month over month and 3.5% year-over-year in May. Private capital investment construction increased 0.1% on a monthly basis and 3.4% annually, while government construction rose 0.2% month-over-month and 3.7% year-over-year.
That relative stability may reflect a market that has already absorbed earlier cost increases. Construction pricing has been elevated for some time and developers have been underwriting deals with those realities in mind. Earlier reports in April tied rising construction costs to the Iran conflict, suggesting that at least some of the current pricing pressure is not new to the system.
In that context, May's data reinforces a key takeaway for CRE decision-makers: while inflation shocks tied to energy can move headline numbers quickly, the underlying economics of development are still being driven by longer-standing cost structures that continue to challenge project feasibility.
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