The Relationship Between Rising Interest Rates and CRE

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Low interest rates were the norm for over a decade, creating a comfortable, predictable landscape for many CRE practitioners. Now, the winds of change are blowing. The current economic climate has shifted, with fluctuating rates ushering in an environment many in the field have not encountered before.

This isn’t just a minor change – it’s a seismic tremor that’s reshaping the terrain of commercial real estate. The unfamiliarity can be disconcerting, even intimidating. But there’s no need for despair. Just as every challenge brings uncertainty, it also carries the seed of opportunity.

The key lies in understanding this new reality and adapting to it. This blog post aims to explore the relationship between fluctuating interest rates and CRE, breaking down the complex dynamics into actionable insights.

A Brief History of Interest Rates

Interest rates are a critical economic tool used by central banks, like the Federal Reserve in the United States, to manage economic growth and inflation. A host of complex factors, such as national debt, economic growth, inflation, and overall market stability, influence them.

In response to the 2008 financial crisis, central banks around the globe significantly reduced interest rates. These steps were taken to stimulate economic activity by making borrowing cheaper, thereby encouraging investment.

For the commercial real estate sector, this extended period of low interest rates made financing for acquisitions and developments more affordable, leading to increased activity and growth in the industry.

However, between 2017 and 2019, we saw a shift in this trend. As global economies began to recover, central banks increased interest rates incrementally to keep inflation in check. This rise had a direct impact on the CRE sector. 

Higher interest rates mean higher borrowing costs, potentially reducing the profitability of real estate investments. Rate increases paused during the COVID pandemic, but the amount of capital stimulus added to the economy made inflation pick up again, which drove the Fed Reserve into action. Fast forward to today, we are once again in an era of rising interest rates, particularly following the Fed’s fastest slew of interest rate hikes in its history in 2022-2023.

As a result, investors became more cautious, and some properties—especially those with lower yields—became less attractive. This period also saw an increased focus on property improvements and management efficiencies to enhance returns in a higher-cost environment.

This fluctuating rate environment has brought new challenges for the CRE sector, influencing investment strategies, property valuations, and financing decisions. Knowing these dynamics helps formulate proactive strategies that can turn potential challenges into opportunities.

Fluctuating Interest Rates and Commercial Real Estate

Interest rates — whether they rise, fall, or remain stable — significantly affect the commercial real estate market. Let’s break down how these fluctuations impact property values, investment decisions, and financing options.

Rising Interest Rates

When interest rates rise, the cost of borrowing increases, potentially leading to decreased property values as the pool of potential buyers shrinks. As Forbes notes, investors may become more selective, focusing on properties with high-income potential to offset these increased financing costs.

Stable Interest Rates

Stable interest rates create a predictable environment for CRE investors. This stability allows for accurate forecasting of potential returns, encouraging long-term planning and investments, particularly in large projects that require substantial upfront capital. However, extended periods of low but stable interest rates could lead to concerns about future inflation, making investors cautious, according to a post on the IMF Blog.

Declining Interest Rates

Declining interest rates make borrowing cheaper, potentially leading to an increase in property values as more investors can enter the market. Lower rates can make real estate investments more attractive compared to other investment types, such as bonds, which offer lower returns. However, a sharp decline in interest rates, often a response to economic downturns, can cause overall economic uncertainty, negatively impacting the CRE market.

Financing Options

Fluctuating interest rates also influence financing options. Fixed-rate loans, which maintain the same interest rate throughout the borrowing period, provide certainty in repayment amounts, making them more attractive in a rising interest rate environment. On the other hand, variable-rate loans, whose interest rates can change over time based on benchmark rates, become riskier with rising rates but are more attractive when rates are falling.

Strategies for Navigating Fluctuating Rates in CRE

As we move away from a prolonged period of low interest rates, it’s essential to adjust strategies and risk modeling accordingly. Here are some strategies to help navigate this changing landscape, particularly in a rising interest rate environment.

Risk Management Strategies

  • Flexible Financing: Depending on your expectations of future interest rates, you might opt for either fixed-rate or variable-rate loans. Fixed-rate loans offer protection against rising rates, while variable-rate loans can be beneficial when rates fall.
  • Interest Rate Hedging: Financial instruments like interest rate swaps allow investors to hedge against interest rate risk. These can be particularly useful when rates are volatile.
  • Strategic Refinancing: If you anticipate a significant change in interest rates, strategic refinancing can help manage borrowing costs. For instance, refinancing to a fixed-rate loan before rates rise can lock in lower costs.

Opportunity Strategies

  • Market Timing: Fluctuating interest rates can create buying opportunities. For example, falling rates often lead to increased property values, presenting a good selling opportunity. Conversely, rising rates could deter some investors, reducing competition for properties and potentially leading to more favorable purchase terms.
  • Investing in Income-Producing Properties: Properties with a steady income stream can provide a buffer against fluctuating interest rates and inflation. Regular income can help cover financing costs and maintain profitability, even if interest rates rise.
  • Leverage Technology for Efficiency: Utilize CRE-specific technology tools to streamline operations, reduce costs, and improve profitability. This can help offset the impact of fluctuating by increasing net operating income.

The Bottom Line: Embracing Changing Interest Rates

The tide is turning in the world of commercial real estate. Rising rates, unfamiliar to many, have begun to make their mark, influencing investment decisions, property values, and financing options. But with understanding and proactive adaptation, you can turn these shifts into opportunities rather than obstacles.

In this ever-evolving industry, staying ahead of the game is crucial. Knowledge is power, and understanding how changing interest rates affect the landscape of CRE can equip you to make informed decisions. This is not a time for complacency but for action.

As you continue to navigate these changing times, remember that you are not alone: Crexi Intelligence allows users to access valuable market insights, including key trends that will help you make informed decisions in a rising interest rate environment.

* Disclaimer: Crexi does not offer financial advice. The information provided is for educational and informational purposes only. Please consult with your financial advisor for personalized guidance.

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Shanti Ryle
Shanti Ryle

Content Marketing Manager

Shanti leads Crexi's content marketing strategies with 7+ years of content development experience, creating everything from blog posts to award-winning podcasts. Previously, she worked on content teams at Snapchat, Weedmaps, and HopSkipDrive as well as developed copy, articles, and media for freelance publications.

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