How Fed Rate Increase Affects Building Owners

Commercial real estate prices are seeing increases in many markets as the Federal Reserve has opted to increase the interest rate for the first time since the 2008 Financial Crisis. According to Moody's Investors Service, commercial real estate prices have risen 93% from a low reached in 2010 and are now 16% above the previous 2007 peak for commercial real estate prices. While the actions of the Fed are affecting many aspects of the commercial real estate market, here is how the Fed rate increase affects building owners.  

Lower Valuations for Commercial Real Estate Properties 

Rising interest rates can have a major impact on commercial real estate because commercial properties are valued by the amount of profits that they can return. Over the long term, higher interest rates mean higher cap rates, which will result in lower valuations for commercial estate properties. As a result, building managers will likely be increasingly pressured to cut costs in order to maintain profitability for property owners. 

Increased Rents for Commercial Real Estate  

Rising interest rates are a sign that the economy is improving. As a result, building owners can expect to see continued higher demand for commercial property in areas where there is already high demand. When rising interest rates occur, future cash flows often reduce in value as a result of inflation. As a result, building owners will likely have to raise rents in order to keep up with the pace of inflation.  

In areas where there is low demand for commercial property, building owners may opt to take a more cautious approach by keeping rents at stable prices, or even by lowering the rents. This ensures that extra pressure on businesses who need to borrow money in order to pay the rents are not at even more of a disadvantage because of the higher interest rates. 

More Businesses May Remain Renters 

As rents rise, more businesses are likely to remain renters. This means that building owners will likely have a larger pool of tenants to choose from. Building owners should opt for tenants with good business credit and rental history in order to provide long term reliable income streams.  

Interest rates in the United States have been at historic lows for some time. However, these low rates were not expected to last forever. The good news is that the Fed is not expected to increase interest rates quickly. This gives building owners plenty of time to consider how they will adjust to the new higher rates. Modifying their investment strategies and property portfolios may be the right solution in light of these new developments.