The Fed has raised interest rates twice so far this year, effectively raising all commercial real estate loan rates. The short term impact is easy to predict. Whether the rate increase is good news or bad news is harder to tell.
The Fed has raised short term interest rates which now range from .75 to 1 percent. Some analysts expect more rate hikes in the immediate future. In the face of these rising interest rates borrowers will likely clamor order to refinance their outstanding mortgages before rates go up any further.
The rate hikes coincide with a “wall of maturities in the CMBS market.” CMBS borrowers will likely need to refinance before the Fed raises rates yet again. However the impact of these rate hikes may be obscure to regular business owners, especially when it comes to property values. Depending on the perspective the rate hikes can be seen as good news, bad news or some combination of both.
On the positive end, higher interest rates could make the commercial real estate market less volatile. Both borrowers and lenders will now have a clear incentive to cut back on any risky lending. Business and property owners may think twice about taking on a new mortgage. Under the higher rates lenders will be far more prudent as to whom they lend money, and banks no doubt will raise borrowing standards. Lenders with lower standards, such as bridge or specialty lenders, will no doubt benefit as a result of the increase. Above all the rate increases by the Fed signal that the US economy is improving and a strong economy is no doubt a net positive for the commercial real state market.
The most obscure impact of rising commercial real estate loan rates is the impact interest rates have on property values.
The historically low interest rates of recent years may have inflated commercial property values. With low interest rates, commercial property owners were able to make more income than they would in a normal economic environment. Commercial property is valued based on its ability to generate income, expressed as a cap rate. A cap rate is the income produced by a property compared to its overall fair market value. The higher interest rates will reduce the income potential of many commercial properties, pushing up cap rates and lowering their overall value. As commercial property values decline loan to value ratios increase. Higher loan to value ratios will make once safe loans appear risky to banks, which may lead to higher down payments or collateral requirements for borrowers.
Higher rates on commercial real estate loans could change financing practices and make capital harder to access.
No doubt borrowers will want to refinance at today’s comparatively low rates. However higher interest rates could also make capital too expensive for some borrowers. Overall this could reduce the sale of commercial real-estate, as some borrowers may not be able to afford mortgages at the new higher interest rates. Banks could see a negative impact as the cost of lending increases. Borrowers may seek smaller loans due to the additional expense of higher interest rates. Some borrowers could simply default unable to keep up with the new higher interest payments on their outstanding mortgages.
It is difficult to predict the impact, positive or negative of the Feds recent rate hikes. Over leveraged land lords could see their property values decline. Lending standards could become stricter and borrowing could become more difficult. The increases are by no means drastic, but they will undoubtedly result in a more conservative lending environment.
Level 4 Funding LLC Private Hard Money Lender
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 42 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.