We’ve been fortunate for more than 30 years because interest rates, in general, have been falling since the early 1980s. Before that moment in time when interest rates first began their slow descent, the prime rate was higher than 20 %, and getting commercial real estate financing wasn’t fun.
So for more than 30 years now we’ve enjoyed decreasing interest rates, making the loan payments on commercial real estate lower and lower, with some intermediate fluctuations along the way.
But the Chief Economist for the National Association of Realtors, Lawrence Yun, has predicted that interest rates on home loans will rise to about 6% or more by the end of 2016, and with this in mind we now need to take a look at what rising interest rates would mean for commercial real estate.
In short, rising interest rates would mean now having higher loan payments when refinancing, and when purchasing commercial real estate, too. As an example of this, let’s say you were going to purchase a property and finance $1,000,000.00 of the purchase price. In simple interest terms, if the interest rate was 7%, you’d be paying $70,000.00 a year in interest. But if the interest rate were instead to rise to 9%, you’d now have $90,000.00 in annual interest expense, an increase of 29% in your total out-of-pocket interest payments.
That’s substantial.
Now let’s look at what could then develop as a result of this;
Your total cash-on-cash spendable return on the property would go down because of the increased annual interest expense. With this in mind, this could create a bit of a stalemate between property sellers and buyers, as the sellers will still want the old price they could get before the increase in interest rates, and the buyers will then want the sellers to lower their prices because their spendable return will now be less at today’s market cap rates.
So as long as neither party needs to buy or sell, we could definitely experience a readjustment period in pricing.
Now when you combine this with people facing higher interest rates on both their home and business loans, there will be a little bit more of a”squeeze” going on that could impact people’s decisions on buying more property. So it’s not just the simple effect of rising interest rates in commercial real estate that we’re talking about, it’s the compound effect of rising interest rates everywhere.
The good news, though, is that those times haven’t arrived yet, but they could be coming. The Chief Economist for the National Association of Realtors doesn’t predict bad news for an Association that really wants to hear good news, unless he believes that he’s got a very good reason.
So is it time to refinance your property right now? Is it time to consider selling your property at today’s prices, before rising interest rates may cause buyers to then demand lower prices, to then compensate them for their lower overall rate of spendable return?
One of the greatest attributes of seasoned commercial real estate investors is they observe where the market is headed, then they take the appropriate action right now.
If you’d like to discuss what the best course of action will be for your commercial real estate needs right now, give me a call.