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How Rising Interest Rates Will Affect Commercial Real Estate Investing

05 22 2017

How Rising Interest Rates Will Affect Commercial Real Estate Investing

When the Federal Reserve raised its key interest rate by 0.25 percentage points in March, analysts and financial advisors alike received a confirmation on the future of U.S. interest rates. While questions had been swirling on the likelihood of future interest rate hikes, the Fed’s rate hike indicated there were likely to be more rate hikes to come in 2017.

However, even someone who’s had an eye on interest rates for the past decade will only have seen rates rise a few times – until the past couple of years, rates were stagnant since 2008’s recession. For those involved in commercial real estate investing, or simply curious about how to invest in commercial real estate, this leaves some questions hanging in the air: What does March’s interest rate mean for the future of interest rates? How will rising interest rates affect commercial real estate investing?

Although some leading financial industry voices have done a top-level coverage, these questions deserve further in-depth analysis. Rising interest rates are generally a good sign for the real estate market, but we believe individuals should still proceed with caution.

Let’s take a closer look at why.

How Interest Rates Affect Commercial Real Estate Investing

Many factors impact the Federal Reserve’s decision to raise or lower the federal funds rate, which is the target interest rate at which banks lend their reserve balances to other banks overnight. The federal funds rate is traditionally used as a key benchmark in financial markets. If that’s the case, then what does a higher interest rate mean for commercial real estate market?

There are several ways to interpret the impact of moving interest rates on commercial real estate investing, both with positive and negative impacts. A higher interest rate makes loans more expensive for borrowers. In the near-term, the prospects of avoiding even higher interest rates down the road may encourage borrowers to refinance – a positive impact for investors. Conversely, higher interest rates can also negatively impact the commercial real estate market, as prospective owners may become more hesitant to borrow in the first place.

There’s reason to believe the Fed’s rate hikes are a good sign for the commercial real estate market, though, and not a bad one. A stronger economy is usually associated with a stronger real estate market, and economic factors like employment rates, GDP, and other figures have all been trending positively over the past couple of years. These good signs for the commercial real estate market are likely to outweigh the potential negative impacts of higher interest rates.

How Regulatory Uncertainty Affects Commercial Real Estate Investing

Despite this optimism, there’s reason for caution in the commercial real estate investing sphere. Most of this caution can be attributed to the uncertain futures of a key set of regulations under President Trump.

Take this example: High long-term interest rates are generally beneficial to lenders, who receive higher payments on each commercial loan they fund. However, there are currently sets of regulations that were put in place after the 2007 financial crisis as an attempt to curb risky lending practices. Arguing that these regulations slow economic growth, Trump has set his sights on their repeal.

However, aside from executive orders, the first few months of Donald Trump’s presidency have been somewhat volatile and slow moving. While he and other Republican lawmakers have advanced toward their goal of fewer regulations, it remains to be seen when – and how – they will ultimately be successful. Additionally, it’s uncertain whether large banking institutions would then prove successful at mitigating risk under minimal oversight.

Rising Interest Rates Have Differing Impacts on Commercial Real Estate Investments

Though rising interest rates aren’t directly indicative of the state of the commercial real estate investing market, there are patterns we can follow – and they tend to indicate that the economy is strengthening in 2016 and 2017.

Investors may take this as a cue to jump right into some commercial real estate investments. Though interest rates give us a clear near-term outlook, political uncertainty prevents us from having a clear long-term outlook. So, what does all this mean for you?

Do your homework. Interest rates may have different practical impacts for you depending on whether you plan to lend on commercial loans, flip a property, or rent out various commercial property types. Do the necessary research, listen to the experts, consult your situation with your financial advisor, and understand you should always be cautious, regardless what your plans are in the real estate investing sphere.

There will always be risk – combat that risk with knowledge.

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