What 2019 Interest Rates Mean for the Commercial Real Estate Investor

The Fed The Federal Reserve, Washington D.C.

The Federal Reserve Board Building in Washington D.C.

Low Interest Rates for Commercial Real Estate

Whenever interest rates rise or fall, it affects numerous sectors of the economy. From banking to real estate, certain businesses pay close attention to rate changes. So when the Federal Reserve makes announcements about rate fluctuations, many people pay attention.

After last month’s meeting, the Fed presented several conclusions. Slowing economic growth in Q1 2019 spurred the Fed to end interest rate hikes for this year. At the same time, the Fed announced it may allow one rate increase in 2020. Although nationwide unemployment remains low, business investments and household spending are also low. In response, the Fed hopes that keeping interest rates low will encourage “maximum employment and price stability.”

The Fed hopes that keeping interest rates low will encourage “maximum employment and price stability.”

The Effect of Lower Interest Rates on Real Estate

Any person, business, or corporation who borrows money will benefit from the lack of rate increases or decreases. Specifically for real estate investors, when interest rates remain low, this often translate into increased investment opportunities. As the cost of borrowing money stays low or even decreases, investors tend to become more active to take advantage of the financial savings.

For example, an investor who previously passed on an opportunity to invest in an office building in Houston may reconsider that opportunity. As a result, lower interest rates directly affect real estate sales, buoying them up as investors sink their cash into commercial properties. In the end, low-interest rates mean the office building market will continue to run up in values in 2019.

The Relationship Between Interest Rates and Cap Rates

The capitalization rate is the expected return on an investment property. This ‘cap rate’ is calculated by “dividing the property’s net operating income (NOI) by the current market value.” As a mathematical formula, it looks like this:

Capitalization Rate = Net Operating Income / Current Market Value

Lower interest rates don’t necessarily produce favorable cap rates.

When interest rates rise, investors pay more to borrow money. Consequently, this drives up the costs of commercial properties. As a result, spending more to borrow money due to higher interest rates cuts into overall profits. Because of this, some investors fear rising interest rates could inflate cap rates, decrease property values, and consequently decrease returns. However, this is an oversimplification of the issue.

Typically, we believe the cap rate will deteriorate upon interest rate increases. The value of a commercial office building asset may decline 5% for every .25% increase by the Federal Reserve. 

At the same time, low interest rates for commercial real estate don’t necessarily produce favorable cap rates. The reality is that other factors affect cap rates as well. Historically, interest rates aren’t the sole factor affecting commercial real estate performance. In the end, there is a relationship between interest rates and cap rates, but it isn’t as close as some might believe.

Why 2019 is a Great Time to Buy Commercial Real Estate (low-interest rate loans)

The Fed’s low-interest rates mean values should continue to rise in Texas’ office building market throughout 2019. Moreover, due to low interest rates for commercial real estate, the remainder of 2019 looks great for commercial real estate investors. By investing now, commercial real estate investors can take advantage of consistently low rates to finance properties at a considerable savings. To learn more about investing in commercial real estate in Houston, Dallas, or San Antonio, contact CXRE today.

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