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The Impact of Rising Interest Rates on Commercial Real Estate

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Real estate investors may have their concerns raised about the current environment of rising interest rates and how this will impact their return on commercial real estate.

To answer the questions of investors, Aaron Gorin, the founder and chief investment officer at Cedar Grove Partners LLC in Woodmere, New York, provides his insight on the impact these rising rates will have on commercial real estate investments.

What Types of Properties Are Affected?

Aaron Gorin states that not all commercial properties will be affected in the same way by rising interest rates. Some may be more vulnerable to this type of environment than others. For example, net lease properties and other fixed income properties may be more at risk. This is due to a fixed monthly rent that cannot be increased with the interest rate, especially when this rate changes at a fast pace during the year.

On the other hand, the debt market, such as real estate debt funds, are a much safer option for investors in an environment with a rising interest rate. Another good option would be to choose properties with equity characteristics, since their return grows with the economy.

What Factors Can Protect Against A Rising Interest Rate Environment?

According to Cedar Grove Partners LLC, there are factors that may be able to protect investors in this particular environment:

Underwriting Practices
Underwriting is the process by which an individual or institution takes on financial risk for a fee. According to Aaron Gorin, this process can help investors mitigate their concerns.

Strengthening Economic Conditions
Economic growth may improve real estate fundamentals by providing a solid NOI (Net Operating Income) growth and thus help to raise the value of real estate at a high enough rate to counter the effects of interest rates.

Cap Rate Spreads
Capitalization rate is the rate of return that an investment company will generate based on their current market value. This simple calculation is a fast way to compare different investment property options. Therefore, these spreads can help to buffer the rising interest rates.

Aaron Gorin of Cedar Grove Partners LLC — how to make smart investments when the environment is chalk-full of rising interest rates

How Can Investors Make Smart Investments In A Rising Interest Rate Environment?

The points mentioned can help protect investors. However, Cedar Grove Partners states that these factors are generally outside of an investor’s control.

Here are a few methods investors can use to protect themselves and keep up with rising interest rates:

Shorten Duration of Property Leases
It is most likely that sectors with long-term leases will be more at risk of underperforming as interest rates and inflation rises. It is wise to shorten the duration of your property leases to adjust for these spikes, especially if inflation rises unexpectedly.

Invest in Property Types with Short-Term Leases
This ties in with the previous point. The economy currently favors rapidly rising interest rates, as a result, it is a good idea to invest in property types that typically have short-term leases while avoiding those with long-term leases, such as retail.

Invest in High-Potential Sectors
When choosing what real estate to invest in, make sure to factor in the rising interest rates when you are estimating your returns. Aaron Gorin states that by choosing real estate with higher potential in returns, you will buffer the negative impact of rising interest rates.

Although an environment of rising interest rates makes real estate investment more of a risk, Cedar Grove Partners LLC suggests taking the above points in consideration to maintain success in your commercial real estate endeavours.

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