When the Federal Reserve shifts interest rate policies, commercial real estate (CRE) responds in various ways.
Changes in borrowing costs, property valuations, and transaction activity can encourage or discourage investment. Investors, lenders, and property owners must monitor these adjustments closely to decide how to position themselves in the market.
This article will explore Federal Reserve policy and how it impacts commercial real estate. We’ll look at how lower interest rates benefit commercial real estate, as well as the challenges this can introduce.
Understanding Federal Reserve Policy and Its Impact on CRE
Interest rates significantly influence the commercial real estate market. The federal funds rate serves as a benchmark that influences borrowing costs across different asset classes.
When rates climb, financing becomes more expensive, and reduced transaction volumes follow. When rates drop, borrowing becomes more affordable, which tends to drive more investment activity.
What is the Federal Funds Rate?
Banks use the federal funds rate to set short-term lending costs for one another, but its impact goes much further—this rate affects everything from credit card rates to commercial real estate loans.
When the rate drops, borrowing gets cheaper. In CRE, this means opening the door for more property acquisitions, new developments, and refinancing at better terms.
High interest rates, on the other hand, increase the cost of financing. This slows transactions and makes real estate investments less enticing.
Why Does the Fed Adjust Interest Rates?
When they adjust interest rates, the overarching goal of the Fed is to maintain economic stability. It’s a delicate act of balancing inflation control with economic growth.
When inflation accelerates beyond the Fed’s target, raising interest rates makes borrowing more expensive, reducing consumer spending and business investment. Then, the Fed needs to act accordingly in an attempt to restore balance.
The relationship between interest rates and real estate markets exemplifies the relevance of Fed policy decisions and how they influence investment strategies.
How Lower Interest Rates Benefit CRE
Traditionally, lower interest rates make it easier to finance commercial real estate deals.
Investors take advantage of better loan terms, refinance existing properties, and move more freely in the market with lower interest rates.
Here are five ways lower interest rates can benefit the commercial real estate industry.
1. Lower Borrowing Costs
When interest rates decline, financing commercial properties becomes more affordable. Lower debt costs allow real estate investors to pursue acquisitions and development projects while maintaining attractive returns.
This increased affordability encourages businesses to expand their operations, adding value to the overall market.
2. Higher Property Valuations
Lower interest rates tend to push property values higher. With cheaper financing, buyers can pay more without cutting into their expected returns.
This is especially true in high-demand sectors like multifamily and industrial real estate, where investor interest stays strong even when the economy shifts.
3. More Transaction Activity
Cheaper financing encourages more real estate transactions. Investors are more willing to buy, and property owners may decide to sell while prices are strong. With capital flowing more freely, deal volume and market activity tend to rise.
4. Refinancing Opportunities
Lower interest rates also benefit investors by giving property owners a chance to refinance, cutting down on debt payments. The savings can go toward upgrades, expansions, new acquisitions, or any other way investors want to strengthen their portfolios.
5. More Demand in Certain Sectors
Some commercial property types benefit more than others when rates decline.
For example, multifamily housing and industrial real estate tend to attract more investment thanks to their steady cash flow potential.
Sectors like retail and office, however, may see mixed results depending on broader economic conditions and consumer trends.
Challenges of Lower Interest Rates
Market adjustments take time, and some investors remain cautious amid economic uncertainty. While lower interest rates do provide opportunities, they also present noteworthy challenges, and we discuss four of them below.
1. Market Lag in Response
Even when the Fed lowers rates, the CRE market doesn’t necessarily react immediately. Investors, lenders, and developers take time to assess economic conditions before committing to new deals.
Transaction volumes can take months to show meaningful increases because buyers and sellers will need to adjust expectations based on new borrowing costs. Lenders may also be slower to ease financing conditions.
Together, these factors create a lag between rate adjustments and increased transaction activity.
Historically, it also takes particular property sectors (including office and retail), longer to adjust compared to sectors like multi-family and industrial, where financing and demand tend to be more responsive.
Market sentiment and investor confidence also play a role in determining how quickly transactions pick up after a rate adjustment. It’s not uncommon for buyers to wait for signs of stability before proceeding with major investments, further prolonging the delay.
2. Uncertain Long-Term Effects
Short-term rate cuts don’t guarantee long-term stability.
If inflation rises or economic conditions change, the Fed may alter course, causing added uncertainty. A rate drop today could lead to future increases, only making it more difficult to forecast borrowing costs.
This uncertainty can cause delays in major deals, particularly in industries with long-term leases and capital commitments. To address anticipated volatility, investors may seek flexible financing and alternate funding sources.
Long-term planning also requires factoring in macroeconomic conditions, global financial trends, and government policies that influence interest rates beyond the Fed’s direct control.
3. Inflation Pressures
Many people recognize that lower rates can boost investment but forget to account for how they may also contribute to inflation.
Higher costs for labor and materials can offset the benefits of reduced borrowing costs. Developers may face rising construction expenses, impacting the feasibility of new projects.
If inflation remains persistent, profit margins will be squeezed as operational costs increase, limiting the overall benefit of cheaper financing.
Not to mention, inflation can also erode the purchasing power of rental income—it will be more difficult for investors to achieve the expected returns on their properties.
In sectors like retail and hospitality, where operational expenses are highly sensitive to inflation, property owners might find it challenging to maintain profitability despite lower interest rates.
As mentioned previously, higher inflation can also lead to increased property tax assessments, only adding to the strain on landlords and developers.
4. Cap Rate Compression
As interest rates decline, cap rates often compress. In other words, property prices rise faster than rental income growth. This dynamic creates valuation concerns, and it becomes more difficult for investors to preserve strong return spreads.
For example, some lenders may require higher down payments or impose stricter underwriting criteria in response to compressed capitalization rates. This makes it harder for investors to leverage the value of their existing properties.
As much as this trend can benefit sellers in the short term, it presents challenges for long-term investors hoping to acquire assets at favorable valuations.
Compressed cap rates push investors toward riskier properties in an effort to boost returns, increasing their exposure to market instability in the process.
Some owners may try to justify high valuations by enhancing operational efficiency or raising rents, but these strategies don’t always unfold as planned in a shaky economic climate.
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Case Studies: How CRE Responds to Interest Rate Changes
Below, we’ll discuss two case studies that illustrate how various asset classes respond under different economic conditions.
Case Study #1: Multifamily Investments Following 2020 Rate Cuts
First, we’ll consider the dramatic drop in CRE transaction volume during the 2020 COVID lockdown and its subsequent rebound after the Fed cut rates to zero.
After the Federal Reserve reduced interest rates in 2020, multifamily properties experienced strong investor demand.
Institutional investors and private equity firms increased their capital allocations toward apartment complexes, capitalizing on low borrowing costs.
Rent growth remained steady, and transaction activity surged, underscoring how lower rates can fuel investment in income-producing assets.
Case Study #2: Office Market Challenges Despite Lower Rates
After the Great Financial Crisis (GFC), the Federal Reserve cut interest rates to near zero to stabilize markets and restore economic confidence.
Lower borrowing costs fueled a rebound in CRE investment, with institutional investors and private equity firms acquiring distressed assets at advantageous terms. Multifamily and industrial properties benefited the most, delivering stable income and long-term growth.
From 2010 to 2015, transaction volumes surged, property valuations climbed, and loan originations gradually recovered as lenders and borrowers adjusted.
Like the first case study, the post-GFC recovery also demonstrates how lower rates drive CRE investment by reducing borrowing costs and encouraging capital deployment.
Comparing High vs. Low Interest Rate Markets
| Factor | High Interest Rates | Low Interest Rates |
| Borrowing Costs | More expensive loans | Cheaper financing |
| Property Valuations | Lower due to higher cap rates | Higher due to increased demand |
| Refinancing Activity | Limited | Increased refinancing |
| Transaction Volume | Lower, as buyers hesitate | Higher, due to attractive rates |
| Asset Classes Benefiting | REITs, well-capitalized firms | Multifamily, industrial, office spaces |
What is Your CRE Strategy?
The Federal Reserve’s rate decisions set the tone for commercial real estate investment. Investors who pay attention to these shifts can get better financing terms and make savvier risk management decisions.
Whether it’s refinancing, purchasing new properties, or assessing market trends, keeping an eye on interest rate movements can make all the difference.
