How Persistently High Oil and Gas Prices Could Affect Luxury Real Estate

As anyone with a car will likely have noticed, oil and gas prices have been at record highs lately. Prices, which had already been steadily rising since the height of the pandemic, shot up shortly after Russia invaded Ukraine in February.

It followed a dip during the pandemic, when global activity ground to a halt. As vaccines were rolled out, lockdowns lifted and economies recovered, energy prices had begun to creep upwards too. Then the war began and the U.S. and other countries announced bans on, or reductions of, Russian oil and gas imports. Brent crude hit $127.98 on March 8, up from $68.87 in December 2021 and $19.33 in April 2020.

More recently, natural gas prices have been hovering near 14-year highs, while oil prices, which came off their early March highs, have again been edging up. A gallon of gasoline in the U.S. cost $4.10 last week, up 43% from a year ago.

It appears the elevated prices will linger for some time. And that could have significant impacts on the housing market, including luxury markets in New York City, London and elsewhere around the world.

From rising inflation and interest rates to a potential new trend in energy-efficient renovations, there is much to consider for prospective home buyers when it comes to long-term real estate planning.

Inflation and Interest Rates

One obvious impact is that higher energy prices feed inflation. In the U.S., the inflation rate rose 8.5% year-over-year in March, its biggest increase in more than 40 years. British consumer price inflation, meanwhile, rose to 7% in March, its highest level in 30 years.

But the worst may be yet to come. According to Olafur Margeirsson, head of global real estate research at Credit Suisse Asset Management, inflation “may even be structurally higher in the future than it was in the most recent past.”

Liam Bailey, global head of research at Knight Frank, said that will lead to slowing of property price gains through this year.

“This current round of inflation from energy prices…is prompting central banks to raise rates, and that will be something which will slow property price growth,” he said. “We’re already seeing the impact.”

In March, following an increase in mortgage rates, U.S. home sales fell by 4% from the previous month and by 8% compared to March 2021, signaling a cooldown in the market.

For Amanda Agati, chief investment officer at PNC Financial Services Group, this is a “pivotal point” in time as it relates to interest rate decisions by the Federal Reserve, or Fed.

“The mortgage rate being above 5%—that’s a key psychological point for a lot of consumers,” she said. “It won’t destroy demand, necessarily, but it definitely will give home buyers pause at these levels if you need a mortgage to move forward.”

She expects the Fed to increase rates by 50 basis points in May, and 25 basis points in every meeting thereafter this year.

But will that affect the luxury buyers, who often do not need financing? Mr. Bailey said the luxury market is not immune from changes in the cost of debt or the cost of living.

“The mainstream and luxury markets—people sort of move between those markets, and they tend to move in tandem,” he said. “Even in the luxury market, the cost of debt is a significant influence on the price people are willing to bid for properties.”

If it becomes more expensive to service debt—and therefore buyers cannot move as easily, pressuring the lower end of the market—that creates a “stickier” market, Mr. Bailey said, because it prevents people from forming chains.

“So everything begins to slow down slightly,” he said.

Mr. Margeirsson said the luxury market can especially be affected in the short- to mid-term, but that ultimately it comes down to the local economy of a city or real estate market.

“Luxury home buyers and investors should be mindful of the local inflation and interest rate dynamics, for they will play a key role in the mid-term dynamic of the local real estate market,” he said.

Mr. Bailey also said that geography can play an important role when it comes to inflation.

“There’s a big difference between Europe and North America,” he said. “The general view is that the U.S. may be moving towards the end of that process, whereas in European markets, and the U.K., to an extent, we’ve still got some way to go.”

The Impact on the Consumer

Higher oil and gas prices also affect the buying power of individual consumers.

“I do think affordability will start to come into the [equation], even at the upper end of the market,” Ms. Agati said.

And while the extra money spent at the gas pump is less likely to impact prime real estate buyers than it will the average consumer, “the luxury market is not immune from broader market signals,” Mr. Bailey said.

What’s more, if prime real estate buyers derive their income from the industries that are being hit, their real estate investment plans could be affected as well.

“If consumers have less purchasing power, they generally buy fewer goods,” Mr. Margeirsson said. “If the luxury buyers own the companies selling those goods, their profits and income will be affected as well.”

In other words, Ms. Agati said, if you think of luxury homebuyers as the chief executives, owners or board members of public companies, “you have to think that they’re very much focused on what rising energy prices will do for profitability and margin expansion potential.”

She is nonetheless “bullish” on the U.S. consumer.

“Even though there are a lot of challenges in the short run…we do think that consumers are in good shape to weather the storm,” Ms. Agati said, adding that there is roughly $2 trillion sitting on consumer balance sheets in the U.S.

The pandemic prevented many consumers from spending as they normally would, so there is pent-up demand for housing as well as other durable goods and services.

“Usually when you get to this phase of the cycle, historically speaking, consumers are exhausted,” she said. “But from a balance sheet perspective, we’re in really good shape.”

While real estate demand isn’t expected to dry up, it may evolve. As mortgage rates rise, for example, that will prevent some buyers from reaching into the luxury market.

“If you don’t need a mortgage it’s not really relevant,” Ms. Agati added. “So it will change who is a luxury homebuyer.”

One demographic that could begin to show more demand for luxury real estate is those who work in the oil and gas industry.

“It seems to me that oil and gas companies have a new lease on life, especially North American shale drillers, and appear to be focused on profits over production in this environment which is leading to positive cash flow for the first time in years,” Ms. Agati said. “So the profitability backdrop and dynamic for the energy sector at large has changed really significantly, but I think the key question is how long does it last?”

Mr. Bailey noted that oil exporting countries will have more wealth to spend as a result of high energy prices.

“Probably within the next one to two years, you’ll see quite an impact in terms of Middle Eastern demand in the U.S. and in Europe,” he said.

Supply Chains and Renovations

The impacts of heightened energy prices are also being felt by people building or renovating properties. That’s because oil and gas are key inputs for raw materials, such as rubber, plastic, chemicals and fiberglass insulation.

“We’ve seen really significant shifts on the part of builders and contractors to move from fixed prices to [contracts] that have escalators in them,” Ms. Agati said. She noted that renovation prices can rise even higher when you account for “significant increases in shipping costs, which are largely a function of rising energy prices.”

Mr. Bailey said there is a renewed concern around supply chains across the globe.

“We’ve seen it recently, in the U.S. and London, that properties which are newly refurbished or brand new—available to sell right now—are trading at a premium,” he said. “For people considering buying properties that need restoration or renovation projects, you’re going to be delayed—it’s going to take a long time to get workers and materials.”

Alternatively, oil and gas prices may impact the home renovation industry in a less immediate way.

“This current rise in energy costs is [leading to] more interest in energy efficiency in buildings,” Mr. Bailey said. “It could well lead people to consider how they could improve their homes or make them more energy efficient—it’s just coming at a bad time in terms of it being difficult to get materials.”

PNC’s Ms. Agati also said we could see “a renovation boom and an upgrade cycle” with a focus on greater energy efficiency.

“That comes in the form of furnaces and energy-efficient windows, but it could also come in the form of solar panel installation or utility investments,” she said, noting that current oil and gas prices are “potentially an important catalyst.”

How to Plan for the Future

So what should prospective luxury real estate buyers be thinking about as they plan for the future? Mr. Bailey’s advice is to “take a sober assessment of the market” right now.

“It’s been an incredibly volatile market over the last year or so, and people have been, for very good reasons, keen to purchase a home that suits their requirements and family needs through the pandemic,” he said.

But he believes both the U.S. and the U.K.—followed by other markets globally— will move away from a seller’s market and towards a buyer’s market over the next 12 months.

“So as an investor, or buyer, you can probably afford to take your time to assess the market,” he said.

Ms. Agati stressed the importance of location when making long-term real estate investment plans.

“If you’re in London, if you’re in Europe, it’s a very different story potentially than what we might be seeing in the U.S.,” she said. “To some degree the U.S. is a bit more in control of its own destiny…because we’re so limited in how much energy and consumption we get from Russia.”

She also said it is important to differentiate between prospective investors and homeowners.

“When I think about luxury homeowners, I tend to think of them as more price elastic,” she said.

If you are building or renovating a home for yourself, you may be less focused on the return on investment, and therefore more willing to go ahead with a contract that has escalators built into it.

As for real estate investors, however, she said they tend to be less price elastic, meaning the return projection is more important in their decision-making process.

“From an investor perspective, the need to make additional investments, which aren’t cheap, around energy efficiency, the need to put more sophisticated wiring and technology in the home…getting the materials—I just think there are a number of factors here that make this point in time much more challenging for an investor as opposed to a homeowner,” Ms. Agati said.

Investors should pause and assess all the variables, she said, noting that the return profile will not be as attractive as it was six to 12 months ago. For those who have time on their side, she said it could be worthwhile to wait before investing, as we could see “some cooling” in the second half of the year or in 2023.

On the other hand, for those looking for a home for their own use, “taking action now is probably smarter than waiting, because we think rates are going to continue to rise,” Ms. Agati said. “Things are going to get more expensive before they get cheaper.”