Interest Rate Hike: Impact on Commercial Real Estate

navpoint  /   September 26, 2022

One of the hottest economic topics nationally is the interest rate hikes that will be imposed by the Federal Reserve this year. Goldman Sachs has predicted between five and seven 25 basis point rate increases over the course of 2022. They are expecting these hikes starting in March or April of this year. HSBC economists on the other hand have predicted a single 50-basis point rate hike in March, followed by four additional 25 basis-point increases over the course of the year.

The impact on Commercial Real Estate of said rate hikes is expected to be seen in Capitalization rates. When debt service liability increases after-debt cash flows decrease. Investors often have specific return criteria known as a “Required Rate of Return”, and when cash flows decrease, cap rates must rise to meet investors’ Required Rate of Return or demand decreases. The dip in demand also could lead to a decrease in value. The record-low interest rate environment we have been experiencing is coming to a close, but we will still be sitting at very low rates relative to our historic timeline shown below.

Figure 1 shows annual interest rates since 1971. The average interest rate seen is 7.8%, culminating with an all-time low of 2.96% at the end of 2021. Expert economists are predicting year-end interest rates for 2022 to be between 3.75%-4%. If these predictions prove true, we will be sitting roughly 4% below the average rate since 1971.

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