Over the past 13 years, building values have continued to increase worldwide. While the increase was caused by many factors that include increasing rental rates and the cost of construction, one undeniable factor in the equation has been extremely low interest rates. Buyers were able to borrow money at very low rates and at significant leverage. That fact is now changing as governing authorities worldwide are increasing their borrowing rates to combat inflation. So how will this change impact commercial real estate values from a macro perspective?
Increasing interest rates will result in the costs of the monthly debt service to increase. This will impact any new loans and existing adjustable interest rate loans. The resulting cost to own the property is higher and this often results in the value of the property decreasing to offset the additional debt service cost.
With increasing interest rates and economic uncertainty, another factor that could come into play will be the amount of leverage available to buyers and borrowers. For example, in most U.S. markets a buyer would be able to borrow about 80% of the money to buy a commercial property using bank financing, and potentially up to 90% of the purchase price if using U.S. Small Business Administration financing. With higher interest rates and higher levels of debt service cost, banks will certainly consider whether they should be loaning up to 80% of the property purchase price to a buyer. If banks squeeze down the amount they are willing to lend to borrowers and buyers, this will definitely put downward pressure on the value of the properties.
The type of property being purchased is going to be a major factor to the available interest rate and amount of leverage available. Industrial markets remain tight and values will remain more stable compared to other building types. Property values will also depend on the submarket and demographics specific for that property, so any leveling-off of price increases or even property price decreases will depend on more than just interest rates.
In a time of increasing interest rates, buyers and borrowers should be cautious about how high a price they are willing to pay or how much they are willing to borrow on a loan. While projections are that interest rates might only increase another percent or maybe two in the next 18 months, history tells us that interest rates could go even higher if inflation rates remain high. The higher interest rates rise, the more commercial property values will be pressured.
If your company is considering purchasing or selling a commercial property, an ITRA Global advisor can provide you with more insight about the changes occurring in the market and available property options. All ITRA Global members exclusively represent tenants and buys and provide principal-level expertise that is based on transparency, integrity, and trust. With members throughout the world, ITRA Global is uniquely positioned to meet all of your real estate advisory needs. CONTACT US to find an expert in your market.
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Article submitted by Wayne Teig / ITRA Global Minneapolis-St. Paul, Minnesota USA
