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How interest rates affect the commercial real estate market

How interest rates affect the commercial real estate market

Real Estate Review

By Ron A. Campana, Jr., Campana Waltz Commercial Real Estate West

On March 17, 2022, the Federal Reserve Bank made its first rate increase since 2018. Since that date, we have experienced 11 rate increases until July 26, 2023, in an effort to curtail inflation. Those increases collectively added 5.25 percent to all interest rates provided to consumers. All of us have felt the pinch of the increases from products we buy and services we use. This column will focus on what these rate increases do to the commercial real estate market.

There are two different types of buyers typically in a commercial transaction: the owner/user who needs a space for him/herself and the investor looking for a return on investment (ROI).

The owner/user is driven by a need for the space to operate a business and subsequently tends to be willing to pay more for a property than an investor. Owner/users also tend to reap the benefit of slightly lower financing because they are a permanent user.

The investor is targeting a return on investment. Therefore, he or she must find a purchase price which gives a solid enough return on his or her money to justify dealing with the risk that accompanies commercial real estate. The current interest rate is hovering around 7.5 percent. So, depending on your expectation for ROI, the level of return will need to be north of this figure to make sense. The only variation of such is the investor with cash or a 1031 tax-deferred exchange.

Investors will compare commercial real estate acquisitions against the return they could earn on Treasuries, certificates of deposit, money market accounts, corporate bonds and even mortgage-backed securities. Commercial real estate acquisitions have a sense of longevity, appreciation and are a mainstay of the economic growth in a community.

So how does any purchaser balance the rising interest rates with the purchase of a commercial property? Simply put, the purchaser offers a lesser purchase price. It is really a balancing act. When interest rates are low, prices tend to be higher. When interest rates are high, the price must come down to achieve the same status quo.

A trick of the trade is altering the call provision in your loan to take advantage of interest rates which are anticipated to go down over the next couple of years. This requires waiving of a penalty if you terminate the financing or an understanding with the lender of a market adjustment. For example, instead of the 5-, 7- or 10-year call we saw in the past with lower rates, we are seeing options for 2-year calls with the same amortization schedule. For investors, instead of a 20-year amortization, look for 25 years, which lowers the monthly payments and increases the cash flow which, in turn, provides a greater ROI.

The higher interest rates have also caused investors not to acquire real estate. They are posturing themselves in a position of quick action with a lowering of interest rates or to seek out owner-financing for all or part of the acquisition. The benefits to owner-financing can be a lesser interest rate where the seller/property owner acts as the bank and the buyer gains the benefit of lower interest rates and savings on the soft costs a bank typically charges, such as an appraisal, loan origination fees and prepayment penalties.

Higher interest rates are not all bad news. For tenants, the increased rates tend to provide tenants with greater posturing on the rent they pay for their lease.

What is the takeaway from all of this? Regardless if you are an owner/user, investor or a tenant, there is value to being well informed. Keep a close tab on economic trends and investment strategies and reach out to a commercial real estate professional who lives in this world. Invariably that person is worth his or her salt in knowing finance trends, but more so, the nuances in the market.


Ron A. Campana, Jr. is the supervising broker with Campana Waltz Commercial Real Estate West. He can be reached at ron@cwcrew.net or at 757-209-2990.

Campana Waltz Commercial Real Estate WEST

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Campana Waltz Commercial Real Estate WEST
1313 Jamestown Road, Suite 201
Williamsburg, VA 23185
(757) 209-2990

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