On March 15, the Federal Reserve announced their decision to raise the short-term interest rate to 0.75% – 1%. The Federal Reserve Report on Monetary Policy reports that rates are expected to continue rising to accommodate changes in labor market conditions, levels of inflation, and financial and international developments. The predicted trajectory for future rates might lead nervous borrowers to refinance their loans sooner than later. So what does this change in the federal funds rate mean for the commercial real estate market? By and large, an increase in the interest rate makes borrowing from banks and other lending institutions more expensive for investors. Even a sub 1% increase in rates can substantially reduce an investor’s annual return on their investment, which may result in a more cautious approach from those looking to enter the CRE market. However, this restrictive effect is just a part of the real estate cycle. A rise in rates stabilizes the market overtime by allowing demand to catch up to the hyper supply in the space market. As a result, capitalization rates will increase and the property values will drop, incentivizing real estate investment once again.
Interest rates are important to monitor, but they should not be the determining factor when building your investment portfolio. They fluctuate as a result of the real estate cycle, but they alone do not reflect the state of the economy. Success in the commercial real estate market is felt by those whose portfolio is capable of surviving the ebbs and flows of the real estate cycle. So instead of focusing on the changing rates, look more towards the long-term economic climate. If the economy is growing, and the Fed feels confident in raising rates, investors should stay the course.