Ask A Question

How will rising interest rates impact the U.S. commercial real estate market?

We are an LP investor in a couple of developments on the East Coast and are looking at a couple of new opportunities. We keep hearing that the Fed is going to raise interest rates at some point in 2018. If this occurs, how will the U.S. commercial real estate market be impacted? Where are the best places to find value if interest rates are raised?

  • Farazad Investments
    March 29, 2018

    Rising interest rates would obviously have an “economical” impact on pricing. Further, the Federal Reserve already raised interest rates and is expected for further increases again. Commercial real estate is already going through a slowdown process; however, it does not mean the “music stops." There is a cycle that tier 1 cities experience every few years, and this cycle is one of them. For LP investors, before you invest, make sure that your funds and structure of capital return and investments are safe. The quality of the developer and his historical performance is extremely important. In my opinion, the good areas of investment are usually tier 1 cities (i.e. New York, Miami, Los Angeles, Dallas, Seattle, etc.).

  • Marcus & Millichap
    March 28, 2018

    Should interest rates rise, rental rates will follow.

  • March 29, 2018

    If the US federal reserve raises interest rates, it would have an negative impact on the US commercial real estate market as it will lead to higher cost of capital which means the lending cost will be higher than before and the IRR or cash yield will drop. And also as a result of the interest rate increase, the spread between the interest rates and yield of commercial real estate will be compressed and property investment would look less attractive than previously, and that would lead to a fleeing of capital from the real estate market to other investments.

  • Polsinelli
    March 28, 2018

    Look at LIBOR. Its already at 2.25%. LIBOR plus an agreed upon spread is the basis of much of the commercial real estate lending in the US particularly on larger transitional commercial assets. Just the expectation of rising US rates is driving up other indexes, which raises the cost of acquisition of real estate assets where debt is part of the capital stack and depresses the overall return on the real estate asset and if drastic enough will cause prices of such assets to drop to be more in line with cap rates acceptable to the market of buyers.

  • Greenberg Traurig, LLP
    April 01, 2018

    The question is one of great debate, though it would seem that rising long term interest rates will have some measurable impact on cap rates and real estate values. The Fed raised its Fed Funds short term rate at its last meeting, which is how it generally addresses interest rates and its influence on the job market and inflation. US short term rates were kept at historically and artificially low rates since the financial crisis in 2009 in an effort to stabilize the economy and have it recover. In a desperate attempt to accelerate the recovery, the Fed then started its massive bond purchase program which also dramatically lowered long term interest rates, a move it had never before undertaken. Now the Fed is in the process of normalizing the short term Feds Fund rate and unwinding its massive bond holdings on its balance sheet, so the combined effect of this is expected to be continued rising short term rates and long term rates over the next few years. Most experts expect, perhaps, another 200-250 bps increase in both short term and long term rates but to be felt gradually over the next couple of years. Many real estate industry experts believe there has to be some impact of increased long term rates on real estate values and cap rates (and a more direct impact than the short term Fed Funds rate increases), but long term rates are market driven and not controlled directly by the Fed, so those increases are harder to predict and often are driven by emotional reactions to perceptions of inflationary pressures and the potential of the economy or labor market overheating. In addition, there is not a direct correlation between increased long term rates, upon which real estate borrowing costs are based, and real estate cap rates. However, since return rates are very much affected by the cost of long term borrowing, there will be some impact on valuations and cap rates for real estate from increased long term interest rates. Most experts do not expect the correlation to be anywhere near 1:1 on cap rates, but it is hard to imagine that the affect will be minimal and historically there has been a material correlation, but since cap rates also are influenced by other factors, such as a stronger economy leading to stronger demand and increasing rents, interest rates are not the only factor in capitalization rates.

  • SPC Advisors, LLC
    April 02, 2018

    Interest rates have been slowly creeping up for the last year. It is true that rising rates may make projects more costly. On the other hand there is an oversupply of debt funding available. Since you describe yourself as an LP investor, the quality of the GP, its connections and sophistication are more important than ever during a period of change. It may make sense to work with a group you trust. or, seek advice about the best situated in a particular industry or market.

  • SPC Advisors, LLC
    April 05, 2018

    There is no question that the Fed plans to keep raising interest rates. The markets are relatively slow in the US as a lot of potential owners are waiting to see if prices will drop. Office leasing has slowed down, retail is continuing to deteriorate although a number of owners are taking steps to repurpose. On the debt side, the non-bank lenders are continuing to proliferate. Investments from Chinese investors dropped significantly. There is no one answer to your question. I assume that you are comfortable with the GP's you invest with. If so, you can rely on them and check the projected returns.