Steady Interest Rates for Commercial Real Estate
Whenever interest rates rise or fall, it affects numerous sectors of the economy. From banking to real estate, most businesses pay close attention to changes in the Federal Funds rate, also known as the Fed Rate.
So when the Federal Reserve makes announcements about rate fluctuations, investors listen closely because these changes can have a big effect on interest rates for commercial real estate.
In 2019, the Fed concluded that slowing economic growth in Q1 required them to end interest rate hikes for the year, while also announcing it may allow one rate increase in 2020.
However, after their Q4 meeting, officials indicated that rates would remain unchanged and no major actions are expected through the next year due to low inflation.
Unemployment rates fell to a 50-year low in 2019 and are expected to fall even further in 2020, but business investments and household spending have remained below average. In response, the Fed hopes that keeping interest rates steady will encourage “maximum employment and price stability.”
The Fed hopes that keeping interest rates low will encourage “maximum employment and price stability.”
How Lower Interest Rates Affect Commercial 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 2020.
The Relationship Between Interest Rates and Cap Rates
The capitalization rate, commonly called “Cap Rate” is the expected return on an investment property. 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 because spending more to borrow money due to higher interest rates cuts into overall profits.
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 when interest rates increase. The value of a commercial office building asset may decline 5% for every .25% increase by the Federal Reserve.
On the other hand, 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. While there is a relationship between interest rates and cap rates, it isn’t as close as some might believe.
Therefore, stable Fed Rates throughout 2020 suggest a more predictable market for CRE investors and consistent cap rates, without the uncertainty caused when Fed Rates rise or fall.
Shop Around for Low-Interest Commercial Real Estate Loans
Interest rates for commercial mortgages vary from lender to lender and from product to product. Since commercial real estate purchases require especially large loans, investors must shop around for the best rates.
Investors also have several different types of loan to choose between for their commercial real estate projects. Loans available to CRE investors include:
- Conventional mortgages,
- SBA (Small Business Administration) loans, and
- USDA (United States Department of Agriculture) loans.
What’s more, there are also construction loans for ground-up developments and Fannie Mae Apartment Loans or Freddie Mac Apartment Loans for multifamily properties. Whatever loan you select, be sure to do your homework so you can make comparisons.
Whatever loan you select, be sure to do your homework by comparing options so you find the best fit, and best rate for your investment.
Why 2020 is a Great Time to Buy Commercial Real Estate
The Fed’s low-interest rates is likely to translate into rising office building values for Texas’ market throughout 2020. On top of that, low interest rates for commercial real estate means that 2020 is shaping into a great year for commercial real estate investors.
Take advantage of consistently low-rate loans by investing now, and finance your property at a considerable savings over recent years.