How Rising Interest Rate Impacts Commercial Real Estate Financing
Updated: May 17, 2022
When the interest rate rises, each industry reacts to it in various ways — and commercial real estate is no exception.
In 2022, the Federal Reserve has planned to increase the interest rate in multiple instances throughout the year, which of course, is going to affect commercial real estate financing in numerous ways.
Small businesses and startups are the ones to suffer
On 4th May, the Federal Reserve announced another rise in the interest rates — which is the second prominent raise in the last 2 months.
As small businesses and startups already have thin profit margins, they find it hard to comply with the rising rates, which cause costlier loans, higher credit card services fees, and of course, difficulty in financing commercial real estate acquisitions.
Furthermore, as we go deeper into 2022 and months pass by, more raises are expected to flow in — which are sure to complicate the situation even more.
All in all, these circumstances cause slower growth for small businesses and startups.
The benchmark is higher than ever
Many commercial real estate lenders use the standard interest rates as their benchmark for their services. Hence, the interest rates one has to pay to them have been rising continuously.
For lower leverage deals, 5- and 10-year interest rates are well in the 3.75%-3.80% range now.
A mixed bag for commercial real estate investors
In normal circumstances, real estate investors don’t loose anything with rising interest rates. As a good hedge, the real estate industry usually benefits from rising interests.
However, being a heavily deep-drive industry, real estate doesn’t benefit when the interest rates are raised to battle inflation.
Interestingly enough, many pieces of evidence claim the short-term real estate cap rates aren’t correlated to the 10-year treasury in any way. In fact, both these metrics are known to be in negative correlation over the span of the last several years.
This trend has been noticed and reported by the chief economist of JLL, Ryan Severino.
If records are to be believed, a 10-year treasury can lead to a better yield than yearly cap rates. In such cases, it’s more profitable for investors to invest in long-term treasuries rather than betting on annual cap rates. It’s both, more profitable, and a tad bit safer.
However, it’s unlikely that investors will stop leveraging cap rates and go all-in for 10-year treasuries. That’s because they believe rentals and net operating income are in for a gradual increase in the premium over the coming period.
In most cases, the sharp rises in the interest rates are likely to affect leverage-based, single-tenant deals which have low cap rates.
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