Rising Rates Unlikely to Be the Death Knell for Commercial Real Estate Growth

Despite a steadily growing economy, commercial real estate (“CRE”) investors cannot ignore rising interest rates and their effect on CRE. Higher interest rates not only increase borrowing costs and return hurdles, but could potentially also reduce property values. Historically however, rising rate environments have coincided with higher economic growth and less restrictive lending conditions and therefore higher CRE prices. In addition, capitalization rate (“cap-rate”) spreads have room to compress in some markets, and net-operating income (“NOI”) growth can offset the effects of rising cap-rates on CRE prices. Long-term leased, stabilized property valuations are most exposed to rising rates, particularly in expensive regions. Rising rates may also slow equity returns, but we believe senior debt should be protected as long as steady growth continues concurrently. In particular, senior debt backed by transitional properties may hold up better in a rising rent and rate environment. While higher rates may slow returns, particularly for CRE equity investors, a change in underlying market fundamentals would be a greater concern for the overall market.