Understanding the Role of Interest Rates in Property Value

Thought of the Week: Assume that when interest rates were 3%, you paid $1,000 for a 10-year bond that made coupon payments of $30 a year. Everything was great. You would collect your $30 every year and then, in 10 years, you would get your $1,000 back. However, what if you have a current need for that $1,000 in year five and interest rates have risen to 7%? Now your bond yielding $30/yr. would only be worth $428.57 ($30/.07). Because the cash flow generated by this asset isn’t changing, your asset is now worth a lot less money. This is exactly what property owners and lenders are facing today. In my example above, unless the investor can wait things out, the only way she will get her original investment back is if interest rates go back down to 3%. This is exactly what the “extend and pretend” strategy is for many real estate borrowers and lenders today. Converting the bond example to a real estate, the investor today is hoping that if they can extend the maturity date of their loans and buy some time, the $3M net cash flow property they bought at a 6% cap rate for $50M (and is now only worth $33.33M at a 9% cap rate) will eventually return to its prior value (or something closer to it) once interest rates go down. The problem is, unlike the "extends and pretends" during the Great Recession when devastating business failures, mass layoffs and frozen credit markets caused real estate values to plummet, time and lower interest rates won’t necessarily heal what ails many real estate investments this time around. Owners who borrowed money between 2012-2021 when interest rates were at historically low levels may never see those rates again. A 50 or 100 basis point rate reduction by the Fed isn’t going to move the needle enough to save most properties. But it’s not just interest rates that have changed. The pandemic brought about changes in the way we work, travel and live. Remote work reduced demand for office space. Zoom, Teams and other video platforms proved to be decent substitutes for in-person meetings thereby reducing the need for a lot of business travel and, therefore, hotel rooms. On-line sales of consumer goods grew rapidly during the pandemic, and this took a toll on brick-and-mortar retail. All of these asset classes face demand challenges that may never go away. As a result, the property throwing off $3M of net cash flow in our above example may now only be generating $2M. Even if interest rates come down, many assets will be worth a lot less than when they were purchased and financed, and more time won’t change these paradigm shifts in demand. In sum, the extend and pretend strategy that worked well for many borrowers and lenders 10-15 years ago is unlikely to work now. A bill is coming due and eventually someone is going to have to pay it.  The sooner the bill is paid, the sooner we can start re-pricing and re-positioning assets for the new world order. #extendandpretend #credit #commercialrealestate

Cap Rate Expansion & Interest Rates 1. MacroEconomic Influences In a low-interest-rate environment, investors accept lower cap rates because the relative return is still attractive compared to other investment options. As interest rates rise, however, investors demand a higher return to compensate for the increased cost of borrowing and the correlated increase in risk. 2. Yield Sensitivity Real estate, as a long-term and capital-intensive investment, is particularly sensitive to changes in interest rates. When rates rise, the appeal of real estate diminishes unless the cap rates in correlation also increases widening the yield spread. 3. Risk Sensitivity Investors view higher interest rates as an indication of increased risk in the market. Consequently, they seek higher cap rates to justify the perceived additional risk associated with borrowing costs and potential fluctuations in property values. How to Navigate Cap Rate Expansion 1. Market Timing Consideration Understanding the cyclical nature of interest rates and their impact on cap rates is crucial for investors. Anticipating rate changes and market drivers allows for strategic decision-making. 2. Risk Management Cap rate expansion is not always negative. It can present opportunities for investors willing to take calculated risks. However, a well thought-out strategy is crucial to navigate potential risks within a rising interest rate environment. 3. Asset Class Diversification Diversifying real estate portfolios across different asset classes and geographic can mitigate the impact of cap rate expansion as each asset may be affected differently. #realestate #cre #finance #investing #multifamily #hospitality #industrial The CS Organization Carbon Ridge Capital Timothy Roman

Do you really know how interest rates impact your real estate deals? Most investors focus on cap rates and cash flow...but miss how forward rates, yield curves, and swap rates silently shape their financing, returns, and timing. 1️⃣ Forward Rates = The Market’s Guess About the Future Think of this like Zillow predicting future home values — it’s a forecast, not a fact. → Helps you decide if you should lock in a long-term loan or wait → Smart investors plan based on where rates are headed, not just where they are 2️⃣Par Rate = The Fair Price of a Loan Just like you'd check comps before buying a house, the par rate shows the “fair” interest rate for debt. → If a loan’s interest rate is higher than the par rate, it might be overpriced → Use this to evaluate whether your financing is a good deal 3️⃣ Yield Curve = Market Vibes The shape of the curve reveals how the market feels about the future. → Upward slope = optimism, growth → Inverted = fear of recession — be cautious → Subtle changes = how the pros are adjusting risk 4️⃣Swap Rates = Lock In Your Costs This is like choosing a fixed-rate mortgage to protect cash flow. → Big players “swap” rates to manage funding costs → Miss the right swap rate? Your returns can take a hit Bottom Line: Understanding interest rates = smarter decisions on when to buy, refi, or raise capital. P.S. Want to learn and invest in commercial real estate? Join us in our exciting projects—whether as an active partner or a passive investor.