How Will Interest Rates and Inflation Affect the Commercial Real Estate Market?

The US Federal Reserve signaled earlier this year that it expects to raise interest rates further this year, which by March 2022 had already risen by a quarter point. Since then, the Federal Reserve has had an additional three quarter point increase in the Fed Rate. Experts believe interest rates will continue to climb well into 2023 as we combat inflation; that’s the highest we’ve seen in the last 40 years. Economists predict that rates could potentially reach as high as 8% and have drastic impacts on cap rates.

But are rising interest rates bad for real estate investors? Here’s why rising interest rates are potentially both a bad and good thing for commercial real estate investors.

High inflation and increasing interest rates worry people because it means everything becomes more expensive to borrow – from mortgages to credit cards and business loans. And higher borrowing costs and mortgage rates, affording a home becomes even more challenging. It doesn’t help that home prices surged during the pandemic due to supply and demand. When interest rates are rising, lenders also tend to be more cautious and tighten their underwriting.

But if high inflation and interest rates are bad news to borrowers, it’s relatively good news for savers and current investors. When interest rates increase, real estate investments, such as income-generating property and multi-family homes, have been able to grow net income

because inflation pushes all prices up, and that includes rent. And when landlords raise rent to keep up with inflation, they generate higher revenues which also increases property value. Also, if you have a fixed-rate mortgage, you’re assured a fixed interest rate and, therefore, constant mortgage payments for the entire term of the loan. And the interest rate will not fluctuate along with fluctuating market conditions.

If you don’t already have a commercial real estate property and are considering investing soon, rising interest rates will affect you because mortgage rates will increase during periods of inflation. Therefore, you may be forced to offset the higher cost of financing by purchasing a lower-priced property. And as rates rise, expect cap rates to follow. However, this also impacts a business’s affordability in buying real estate. With fewer companies acquiring their own real estate, there will be an increase in demand to rent commercial spaces for their operations. We know that higher interest rates are the response to higher inflation. Because you can raise rent to keep up with inflation, this means higher revenue. Low vacancy rates and few new commercial real estate constructions mean positive news for investors who worry about competition.

However, slower commercial real estate price growth is to be expected, and increasing interest rates may impact your desired return. But ultimately, in times of high inflation and rising interest rates, real estate is still considered a comparatively safe investment strategy.

If you’d like more information on the current debt market, or investment opportunities that are considered good in inflationary times, please reach out to info@cbicommercial.com.