Every business is created and commissioned with one of its sole aims of being profitable. However, this can only be possible when the business owners and entrepreneurs can actualize a significant increase in the demand for their goods and services, which causes an increase in their income rate.
Higher interest rates occur when money lenders must pay an increased amount of money to their investors than the initial amount of money borrowed.
Higher interest rates limit the percentage of individuals seeking to obtain loans for their start-up enterprises and businesses. This action decreases the expansion of businesses hampering the development of a nation’s economy in the process.
Commercial Real Estate is classified into four different categories, which are as follows;
These properties are specially built using architectural designs that best suit individuals to enable them to carry out activities specific to the action executed in the establishment.
These structures are designed to enable individuals to perform specific activities. They can be in power plants, warehouses, malls, etc. They are located mostly in areas distant from housing settlements to prevent any form of complications or hazards.
These types of buildings are erected for the sole aim of providing housing settlements for individuals. They vary in size, space, and appearance. They include; apartments, flats, duplex, condominiums, penthouses, semi-detached, etc.
These buildings are leased out at an agreed-upon price to individuals seeking to carry out an activity until the lease is elapsed. These activities encircle social gatherings, malls, etc.
Effects of Higher Interest Rates on the CRE Market
The commercial real estate market is impacted positively and negatively by increase in interest rates. The effects of the increased interest rates will further determine and influence individuals in making the necessary decision concerning their businesses.
The Capitalization rate (cap rate) is the required amount of return on investment investors make. It is generated by dividing the Net operating income by the current market value.
Positive Effects of Higher Interest Rate
When there is an increase in the interest rate level on business owners and entrepreneurs, it causes a growth in the economy of a country or state. An improved economy will serve as a haven for individuals venturing into businesses to see the possibilities of succeeding as the policies surrounding business ownership will give them the required room to grow their business properly and amass the necessary profit from it.
Negative Effects of Higher Interest Rate
The expenditure cost of building and owning a business will increase with a higher interest rate. This will cause a limit in the number of goods and services provided by entrepreneurs, a higher cost of rent for commercial real estate, and the foreclosure of businesses that cannot get back enough income to pay back their loans and continue their businesses.
Decrease in Capitalization Rate:
An increase in the interest rate will affect the expected cap rate of investors due to the demand of spending more money which will require business owners to borrow more funds. When entrepreneurs lend more funds to meet their market target, investors tend to lose more money if the business fails to reach its expected valuation.
While the media pundits proclaim a high interest rate environment will be the downfall of the CRE industry, it’s important to cut the noise and explore the fundamental analysis. There are some negative effects of the changing times, but there are also some clear benefits to understand and consider while we move further into the roaring 20’s.