On the backside of historically low interest rates, many express concern about rising rates and their impact on real estate pricing. Commercial real estate is expected to perform well amidst economic uncertainty; however, an increase in rates will influence property pricing.
There is oftentimes a mirrored relationship between interest, and cap rates (the relationship between an income-producing property’s net operating income, and its value); as interest rates rise, so do cap rates. As cap rates rise, pricing decreases. Let’s take for example a property with an asking price of $2,000,000 with a net operating income of $100,000. Let’s also say this is a strong single-tenant net leased asset with a long-term (10+ years) lease in place. A year ago, an investor could acquire this asset with 25% down at an interest rate of 3.50%, resulting in an annual after-debt cash flow of just under $10,000. In today’s increasing interest rate environment, a full point higher than a year ago, this investor would not even consider acquiring this asset as the annual after-debt service cash flow is zero. To match the initial annual after-debt cash flow, the cap rate would need to shift from 5.00% to 5.56%, which would require a 10% reduction in the asking price, assuming no changes to the tenant and lease in place. There is no doubt that as interest rates continue to rise, pricing will eventually decrease as there will be less demand and buyers in the market. The question is how long will it take, and how high do interest rates need to get, for sellers to begin dropping prices?
Selling commercial property while rates are low relative to historical averages is often the best way to extract as much value as possible out of assets. NavPoint Real Estate Group is ready to help you determine the best course of action for your specific circumstance in these economically uncertain times.