The Fed cut rates by 0.25% in September this year, bringing the federal funds rate — which refers to the short-term rate banks charge each other for overnight loans — down to 4.00% to 4.25%.
For commercial real estate investors, rate cuts do more than reduce borrowing costs. They can shake up property values and change buyer and seller expectations, or even revive deals that previously didn’t stack up.
Fast facts: How commercial real estate lending responds to interest rate shifts
- When rates rise, your monthly debt obligations increase, making financing more expensive and reducing the number of qualified buyers.
- When rates fall, borrowing becomes more manageable, improving affordability and encouraging more transactions.
- Interest rates affect commercial real estate appraisal outcomes indirectly by moving cap rates and deal activity, and by changing how investors evaluate risk and value.
- Different commercial property types react differently to rate changes. Their sensitivity often ties back to factors such as lease terms and tenant strength, as well as how easily the asset can be traded.
- When interest rates climb, buyer and seller expectations often drift apart. This can slow your negotiations and limit the volume of comparable sales, or even add more steps to underwriting.
- During shifting rate cycles, lenders and financial institutions benefit from credible valuations that support informed decision-making, even when market conditions feel uncertain.
Will lower interest rates boost commercial property values?
CBRE suggests that declining interest rates may help push the commercial real estate sector forward.
The firm notes that reduced hedging costs could encourage more overseas investors to place capital in US markets. If this happens, increased investment activity may create some degree of cap rate compression.
At the same time, lower borrowing costs can help limit any upward pressure on cap rates.
If this outlook plays out, basic valuation math indicates that CRE property values could rise as cap rates compress, assuming that the net operating income stays stable.
But experts remain divided
Despite this potential, not all experts agree on how much falling rates will influence commercial real estate performance.
Just as Federal Reserve officials showed differing views on the timing of rate cuts, industry analysts also have different opinions on how lower borrowing costs could impact the market.
According to the NREI, the most recent 0.25% rate cut may not automatically spark additional investor demand.
The publication points out that although interest rates have generally trended downward for the past decade, cap rates have not fallen at the same pace as Treasury yields.
CBRE’s First Half 2019 US Cap Rate Survey Snapshot seems to back this up — it showed that capitalization rates across all major property categories moved less than 0.10% in either direction during the first half of 2019.
This illustrates that cap rates may not always shift quickly or uniformly, even in periods of declining interest rates.
Do certain commercial property types gain more from lower rates?
When it appeared last year that the Federal Reserve was preparing for additional rate increases, JLL started examining how different investment property types might react.
The firm observed that some commercial assets respond more sharply to rate movements than others.
If you own properties with long-term, fixed rent schedules, like many net lease assets, they can become riskier during rate shifts because their income streams adjust slowly.
In contrast, properties with shorter lease terms behave more like stocks/equities. Since rents reset more often, you can adjust more quickly in response to changing interest rates or economic conditions.
What do lower interest rates mean for multifamily investors?
If you own a multifamily property, lower interest rates mean that your loan payments shrink, so your property’s income covers the debt more comfortably. These lower borrowing costs can create a wide range of opportunities for you, including:
Refinancing existing properties
If your loans are coming up for renewal, refinancing at a lower rate could save you money over time. It can also ease cash flow and free up capital you could use for renovations or your next acquisition.
Expanding your rental portfolios
The recent 25 bps cut to the Fed funds rate can lower your borrowing costs if you’re relying on short-term financing, like construction loans.
That cheaper financing can help you move forward with projects in markets where values are still stabilizing — such as Los Angeles and San Francisco — where high living costs haven’t slowed renter demand, but deal activity has stayed cautious.
A lower-rate environment may also give you room to diversify your portfolio by expanding into mixed-use, retail, or industrial properties.
Of course, even in a lower-rate environment, timing still matters. Interest rate trends over the past two decades show that ‘higher for longer’ remains a relative concept.
While you can expect additional cuts to short-term rates, mortgage rates will continue to follow their own path.
Because of this, you need to be prepared to act quickly when favorable rate conditions appear.
What’s the relationship between commercial property values and interest rates?
Interest rates directly affect how commercial real estate is valued using the income approach.
Lower interest rates reduce borrowing costs, which improves net cash flow and often raises what investors are willing to pay for a property.
Here’s why that happens: Investors look at how much money a building earns after expenses (Net Operating Income), and how much of that income is left after paying the mortgage (Net Cash Flow).
When interest rates fall, loan payments go down, so more income flows through to the investor.
Because many buyers treat that income like a return, stronger cash flow tends to push prices higher.
The same property can become more valuable simply because it costs less to finance.
How can interest rates affect the financial performance of my commercial real estate property?
One advantage of commercial real estate is the potential for positive leverage, which happens when your property earns a higher return than what you pay in interest on your loan.
For example, if you buy a property with a 6% cap rate and borrow at 3.5%, the difference — or spread — can boost your overall return.
- Let’s say that you buy a property worth $1 million with a Net Operating Income (NOI) of $60,000. That’s a cap rate of 6% ($60,000 ÷ $1 million).
- If your annual debt service is $35,000, your Net Cash Flow (NCF) — what’s left after covering loan payments — is $25,000.
- That $25,000 is a 2.5% return relative to the total property value ($25,000 ÷ $1 million).
Keep in mind that this simple example does NOT include other benefits like tax savings from depreciation or potential increases in property value.
But even without those, a 2.5% cash return on the full property value compares favorably to the current 10-year Treasury yield of 1.5%.
Interest rates are just one part of a much bigger picture
It’s easy to assume that lower interest rates automatically push yields and property values upward. But be careful — interest rates don’t always tell the whole story.
They move with broader economic conditions, and those conditions can limit or even cancel out the benefits of lower borrowing costs.
For example, if rent growth stalls or property income becomes less reliable, your returns can still suffer.
That’s why it’s not enough to follow interest rate trends on their own.
You need to read what those rates are reacting to, because the conditions behind a rate cut may raise new risks for your portfolio.
How can you navigate fluctuations in commercial real estate rates?
There are things you can do as a commercial property investor to reduce your risk and uncover new opportunities as interest rates change.
Lock in fixed rates
Securing a fixed-rate loan can help protect against future rate increases. With stable financing costs throughout the loan term, you can predict and plan your long-term cash flow with more confidence.
Diversify your portfolio
Spread your risk by investing across different property types, including residential and industrial, and across multiple geographic areas. Diversifying this way can help cushion your CRE portfolio if one sector or location takes a hit.
Focus on cash-flow-driven properties
Rising financing costs are easier to manage when your properties produce consistent income. You’ll have more breathing room to cover debt, without relying entirely on future appreciation.
Be prepared for refinancing
If refinancing is part of your long-term plan, act before rates climb. Refinancing before rates rise lets you secure lower long-term payments while they’re still available.
And if traditional financing doesn’t pencil out, consider alternatives like private funding or partnership deals to keep your projects moving.
Monitor market conditions
Keeping up with economic trends and Federal Reserve policy decisions is essential so you can adjust strategies accordingly and are not caught off guard mid-transaction.
For example, if borrowing costs are rising, it may make sense to delay acquisitions or revise offer prices to reflect more expensive financing.
Find a reliable financing partner
Working with a financing partner who understands commercial real estate makes it easier to manage changing interest rates.
At Private Capital Investors, you will find a team that is always ready to support you as both a direct lender and an advisor.
Call us at 972-865-6206 to begin the conversation and explore the options available to you.
