Higher Interest Rates Haven’t Deterred Investment

The combination of inflation and major geopolitical events, like the Russia-Ukraine conflict, has created a more volatile market environment for commercial real estate investment and higher interest rates. In the first quarter alone, the cost of fixed-rate debt is up 80 basis points, on average, and floating-rate debt is up 20 basis points, according to data from Chatham.

“While there was a moment of dramatic spot volatility as capital came flooding back to the U.S. Treasury market in a flight to safety, pushing yields into the low 1.7%’s, it seems as though the Treasury market may be pursuing its previous course of rising yields in response to indications of a rising Fed Funds rate,” Jaran Burt, director of valuations at Chatham, tells GlobeSt.com. “The Fed has indicated its intention to combat inflation by raising interest rates, so while capital may get more expensive, there is no indication of a looming collapse of liquidity in the capital markets due to the conflict in Ukraine.”

The higher cost of capital will certainly require investors to adjust underwriting standards, but for now, investors have not been deterred by the changing market conditions. “Investment committees and their investors are having to adjust expectations to a higher cost of capital on the debt side,”, tells GlobeSt.com. [However], although underwriting has changed, transactions continue.”

Despite the ample liquidity in the market, there are some challenges placing capital in the current market, because cap rates have yet to adjust to the new market conditions. Burt’s clients have admitted that “something has to give” for investment activity to continue at the current pace. “Stabilized industrial and multifamily assets, which have been in favor for a long time, have been affected by the increased cost of debt,” he explains. “In some cases, we’ve heard investors changing the debt strategy because typical mortgage debt and the elevated levels isn’t accretive to the investment unless you assume significant future rent increases.”

This quarter, interest rates for fixed-rate debt have continued to grow. “As we approach the end of quarter two, it looks like fixed interest rates are starting in the mid 4% range for long-term fixed-rate loans. Spreads are a bit lower for shorter terms. Floating-rate spreads widened a bit in quarter one, but haven’t been as volatile as the fixed-rate loan market,” says Burt, adding that the pendulum has swung back and forth this year, making it hard to make predictions about the future.