Commercial Property Outlook in a Rising Rate Environment

commercial real estate values

With an anticipated federal funds rate hike on the horizon, how will commercial real estate values be affected?

As the Federal Reserve looks to normalize monetary policy after a sustained period of exceptionally low interest rates, some commercial real estate (CRE) investors, developers and lenders are worried that CRE values will be negatively affected under the assumption that when interest rates rise, CRE values will fall. This relationship seems intuitive at first — rising benchmark interest rates, like Treasuries, should cause all yield-oriented investments to be less attractive. On closer examination, however, the relationship between interest rates and CRE values is much more nuanced. The trajectory of capitalization rates (cap rates) and real estate values is also impacted by other significant drivers like, demand and supply changes, transaction activity and trends in the overall economy.

At the broadest level, an uptick in the federal funds rate may make it more expensive to develop new projects and refinance certain debt, and possibly engender a reactionary sell-off in publicly traded real estate investment trusts (REITs). And yet, as it stands now, relative to historical averages over the last 30 years, the spread between the 10-year Treasury and CRE yields appears to allow room for further compression, and this suggests that CRE values are not immediately threatened by rising interest rates. This seems especially so as other forces buttress real estate values, like record amounts of inbound capital, available private equity “dry powder,” a generally positive economic outlook (albeit with clear caveats) and strong CRE fundamentals.

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