Founder's Note
Two inflation reports landed this week and they do not tell the same story. Friday's consumer print put prices up 3.4% over the year, with core at 2.4%. Thursday's producer print put the prices businesses pay up 5.4%, and one layer deeper, at the raw inputs, 11.3%. The household is living in a 3% world. Anyone who has to buy materials is living in a 9% one.
That gap stops being an abstraction the moment a deal has a construction budget in it. Associated Builders and Contractors ran the same data and found construction input prices up 8.9% over the year. Now put that next to what the building is allowed to charge. Shelter rose 3.0% over the year. Rent itself rose 0.2% in the month. Costs are compounding at roughly three times the rent that is supposed to cover them.
The Fed meets Wednesday, September 16, and the market has it raising, which decides what a finished building is worth. It says nothing about what a building costs to make, and this week that second number moved hard. My read: for product already standing, cost inflation is a moat, because the competition cannot be delivered at these numbers. For anything with a shovel in the plan, the budget is now the primary risk, ahead of the rate.
This Week in Markets
1. Inflation held at 3.4% in August, and gasoline did most of the work
The consumer price index rose 0.4% in August and 3.4% over the twelve months, with core inflation at 0.3% on the month and 2.4% over the year, a touch hotter than expected. The split underneath is the point. Energy rose 16.3% over the year and gasoline 27.4%, accounting for more than a third of the entire monthly increase on its own. Shelter, the largest single component, rose just 3.0% over the year, and both rent and owners' equivalent rent rose 0.2% in August.
Why it matters: Shelter is now one of the slower lines in the index while the things a tenant cannot opt out of run far hotter. Your renter is being squeezed by costs that never appear on your rent roll.
2. The ten-year hit 4.96% and the market now expects a hike
The ten-year Treasury finished Friday at 4.96% and the two-year at 4.63%. Freddie Mac put the 30-year fixed mortgage at 6.76% for the week ending September 10, up from 6.71% and against 6.35% a year ago. After the two inflation prints, futures moved to roughly 80% odds of a quarter-point increase on Wednesday, and both Goldman Sachs and J.P. Morgan shifted to a hike. It would be the first in more than three years.
Why it matters: A near 5% risk-free rate is the hurdle every deal is quietly competing against. Worth asking: what rate does the refinance assume, and what happens to the exit if the ten-year is still near 5% at the end of the hold?
3. Construction input prices rose 8.9% over the year, more than double the CPI
Thursday's producer price index put final demand up 5.4% over the twelve months, with goods up 1.1% in the month, and stage one intermediate demand, the raw inputs furthest up the chain, up 11.3% over the year. Associated Builders and Contractors ran the construction cut of the same data: input prices to construction rose 1.2% in August and are 8.9% higher than a year ago. Chief economist Anirban Basu said iron and steel, softwood lumber, switchgear and copper wire are "now up more than 10% year over year," and warned the escalation "is likely to weigh on profitability over the next several months."
Why it matters: This cuts two ways, depending on whether your deal owns a building or is trying to make one. Already standing: replacement cost is rising underneath you, and that is a moat. Still to be built: the budget is being repriced while the rent goes up 3.0%.
The Take
Three numbers landed this week and they describe three different economies. Consumers paid 3.4% more than a year ago. Businesses paid 5.4% more. Contractors paid 8.9% more. Those are not rounding differences, they are a wedge, and it opens in a single direction: the further up the supply chain you sit, the worse the inflation you are actually living with. At the very top of that chain, stage one intermediate demand is running 11.3%.
For two years the standard question about a real estate deal has been a rate question. What does the debt cost, what does the refinance assume, what happens at the exit. Those are still the right questions and Wednesday may sharpen them. But a rate is a price you negotiate once and then live with. A construction budget is a price you discover in pieces, line by line, over the length of the job, and this week it got repriced by 8.9% while the rent it has to support went up 3.0%. If a deal has a shovel in it, that is the larger uncertainty now, and it is the one almost nobody in my inbox is asking about.
One. Ask what the budget assumed, and when. A pro forma assembled on 2025 bids is already wrong by roughly 9% on materials. A 10% contingency set before this repricing is not a contingency any more, it is the gap.
Two. Ask who eats the overage, because this one has a real answer. A fixed-price contract puts it on the contractor. Cost-plus puts it on you. A sponsor who owns the contractor has aligned the two, which is not the same as being immune, since they buy the same steel at the same price. What it removes is the bid markup and the incentive to hide the number.
Three. Ask what happens if they are wrong anyway. Basis is the only real defense. A renovation bought at 50% to 70% of after-repair value has room to absorb a budget that comes in over. One bought near full value does not.
The flip side deserves saying, because it is the comfortable half and therefore the one people repeat without checking. If you already own the building, every bit of this is happening in your favor. Each month input costs run near 9%, the competition that would have gone up next door gets less likely, and the replacement cost of what you own rises underneath you. That is real, and it is most of the argument for existing, well-leased product right now.
But be precise about which one you are actually buying, because the two get blurred constantly. Owning a finished building is a bet that replacement cost keeps rising. Renovating and developing is a bet on beating replacement cost while it rises. Those are opposite positions in the same market and they deserve opposite questions. Target returns remain targets, development carries construction and completion risk a stabilized building does not, and a budget can run over no matter whose name is on the contract. Ask what the contingency is before you ask what the return is.