Impact of Tighter Monetary Policy on Commercial Assets

A whammy: inflation revs up the acceleration engine and, as a response, the Fed makes the biggest single hike in interest rates—75 basis points—in four decades, with the promise of more to come. The changes in monetary policy are causing rising issues for capital markets and financing for commercial real estate, according to a report from Marcus & Millichap.

“The higher-than-anticipated 75 basis point June bump in the federal funds rate, and guidance of a similar move in July, have financiers re-evaluating their offerings,” the report says. “Lenders that benchmark to credit markets, including CMBS and life insurance companies, may begin to push their spreads and their quoted rates higher. Banks and other balance sheet lenders may hold the line a bit longer, especially for borrowers they have a strong relationship with.”

But the future, at least near-term, is clear. Lending rates are going higher and that means challenges for investors and developers.

This summer, those in the process of getting financing could find lenders looking for a rate adjustment upwards. Maybe a buyer will have to take on the additional financial burden, or leverage may go down. Then again, buyers may attempt to renegotiate deals to get terms that enable an ultimately profitable deal on their end.

Another possibility is that investment funds newer to CRE, which had depended on easy monetary policy, might find that the combination of prices and higher rates make it too difficult to get the return their investors expect. That could mean a drop in the number of buyers, reducing demand and cause prices to begin cooling to some degree, though that could have the additional effect of lowering value of existing properties and, so, increase existing loan-to-value ratios. Such changes could potentially affect loan covenants.

 “The impact of rising rates will depend on a variety of factors,” says the report. “The type of lender the buyer is using, and the buyer’s relationship with that lender, will have a notable influence on terms. The forward-looking supply and demand metrics for each property is also critical, as is whether there is a value-add component.” If future cash streams effectively hedge inflation and forward rent growth, things might be fine. 

But, according to the Marcus & Millichap report, widespread corrections might not happen. There are still enormous volumes of capital chasing CRE properties, and their perceived abilities to help hedge against inflation, “so even though interest rates went up more than many expected and the expectation gap between buyers and sellers may widen, a broad-based pricing correction remains improbable.”