Real estate practitioners mostly downplayed the immediate impact that Wednesday’s widely anticipated interest rate hike by the Federal Reserve will likely have on the industry, but they also noted the significant challenges that reinforced expectations for a “higher-for-longer” rate environment portends for financing and project advancement.

In its Sept. 15-16 meeting, the Fed’s Open Market Committee voted 12-0 to raise the target range for the federal funds rate for the first time since 2023, increasing it by 0.25% to the 3.75% to 4% range. The vast majority of committee members also indicated leanings toward another rate increase before the end of 2026.

Addressing the press, Fed Chair Kevin Warsh said the decision was supported by the combination of recent data indicating a solid economy and labor market, and inflation being stuck around 3.4% — well above the Fed’s 2% target — as a result of geopolitical instability. He also emphasized the Fed’s commitment to pursuing price stability and full employment, despite calls for lower rates from President Donald Trump, who appointed him.

Lawyers and other real estate professionals who shared insights with Law360 Real Estate Authority agreed that the real estate industry, like the broader market, had already largely priced in higher interest rates and the potential rate increase, with several suggesting the Fed’s action could actually provide a degree of greater certainty about the direction rates are headed.

But while that may help ease some buyer-seller logjams, it does not remove the pressures that higher rates typically produce in real estate.

“The more significant consideration for the commercial real estate sector may be what comes next. Market participants will be watching closely for indications that today’s action will be followed by additional rate increases before year-end, which could have broader implications for financing decisions, transaction activity and investment strategies,” said Ferdinand Gallo, a real estate investment partner at Morgan Lewis & Bockius LLP.

Increased Clarity

More so than the amount of the rate hike, one of the immediate effects of the Fed’s action is that it reduces ambiguity about its willingness to increase rates and what direction it is heading. With many in the real estate industry having entered the year hoping to see rate relief, Wednesday’s action may deliver a reality check that could lead to some movement on the transactions front, several experts suggested.

“Buyers have been telling sellers for a while now that pricing needs to adjust to the cost of capital, and sellers have largely been reluctant to accept that,” Brett Forman, managing partner of Forman Capital, said. “A rate increase, even a small one, removes some of the ambiguity and makes it harder for sellers to wait out the market.”

Josh Rubin, a New York-based real estate agent with Douglas Elliman, said this can work both ways, as buyers and sellers have been adjusting for several years now to higher borrowing costs.

“If anything, greater clarity about the direction of rates may help people who have been sitting on the sidelines waiting finally [to] make decisions,” he said.

While higher rates pose challenges for financing, Naheem Harris, co-chair of the real estate financing practice at Akerman LLP, said he does not “think that means that we’re pencils down on closing transactions.”

“There is still significant capital looking to be deployed, and we continue to see lenders and borrowers find creative ways to transact, utilizing loan extensions, preferred equity, mezzanine capital and other financing structures,” he said. “If the Fed is signaling that meaningful rate relief is not right around the corner, I think we may see more market participants stop waiting for yesterday’s rates to return and start figuring out how to transact in the rate environment we actually have.”

Financing Pressures

But while the trajectory of interest rates may now be clearer, that will offer little solace to the many property owners approaching loan maturities.

“If rates move higher again, it puts more pressure on the ‘wall of maturities’ coming due industrywide,” Forman said. “Floating-rate loans in particular become harder to service as debt service coverage ratios tighten, and in some cases there isn’t enough cash flow from the asset to comfortably make payments.”

Troutman Pepper Locke partner Dan Valenti also noted that increased rates means less net operating income, which means a lower debt service coverage ratio, or DSCR, a primary metric used to underwrite the financial health of a property and loan risk.

“For deals in the pipeline where the lenders did not previously take into account the possibility of rate hikes, those loans risk being resized,” Valenti said. “For in-place loans, the pressure on the DSCR may push the DSCR down so low that cash management provisions would be triggered, giving the lender more control over how cash at the property is applied, and for some borrowers may mean that they don’t meet the DSCR hurdles required to be achieved in order to extend loans facing maturity.”

Andrew Hellinger, co-principal of Miami-based development and management firm Urban-X Group, noted that the most pressure may arise with deals that closed from 2021 through 2023, when capital was at historically low costs.

“As those come up for refinancing, the spread between cap rates and interest rates has gotten too thin for a lot of them, and that’s when the underwriting gets harder,” he said.

Morgan Lewis’ Gallo suggested there might be an uptick in demand for fixed-rate loans.

“More risk-averse investors also may take a closer look at the cost of interest-rate hedging and weigh that expense against the certainty of a higher fixed interest rate,” he said.

Danny Diaz Leyva, who leads the Florida real estate practice at Day Pitney, said borrowers who believe another increase is coming may also have incentive to refinance or lock in capital sooner rather than later.

“Developers, owners and investors who had been underwriting a gradual compression in rates now have to confront the possibility that borrowing costs remain even higher for longer,” he said, but added, “For well-capitalized investors, however, periods of dislocation can also create opportunity, particularly as refinancing pressure begins to separate fundamentally strong assets from those that were dependent on inexpensive leverage.”

Contrasting Sectors

The experts said they expect the impact of rate increases to vary across sectors.

Multifamily borrowers in markets that are still absorbing new supply may feel additional pressure, particularly where rent growth has not kept pace with rising debt service and refinancing costs, Akerman’s Harris said.

Meanwhile, Trevor Adler, a real estate partner at Hogan Lovells Cadwalader, said he anticipates a “divide” between office and industrial.

“Office enters this cycle already capitalized as a distressed asset, so higher rates will compound issues for many office properties, while industrial’s short lease rollovers and mark-to-market rent growth let owners re-underwrite into the higher rate,” he said.

The impact could also extend to one of the industry’s hottest segments.

“Even data centers, which have been the belle of the ball of late in commercial real estate, may be impacted by the rate increase, given how capital intensive the sector is,” Harris said.

On the housing front, the elevated rate environment will continue to weigh on affordability, transaction volume and housing starts in an undersupplied market, Noah Breakstone, CEO of development and land investment firm BTI Partners, predicted.

“Compounding these pressures, consumer confidence has fallen to its lowest levels in years, further dampening willingness to make major purchases such as homes,” he said. “Existing homeowners with locked-in lower rates remain relatively insulated, but prospective buyers and new construction activity face ongoing increased headwinds until longer-term yields stabilize or decline.”

Coupled with high construction and insurance costs, more expensive financing is only likely to place another hurdle in the way of development projects, Keith Poliakoff, a partner at Florida-based Government Law Group, said.

But Tyler Davis, president of Saunders Real Estate, said that while rising rates typically slow deal flow, if the rate increase helps with the Fed’s intended goal of bringing inflation under control, that could support the market’s long-term health.

“The full impact will ultimately depend on how the rate increase affects borrowing costs, inflation expectations, asset pricing and buyer sentiment in the months ahead,” he said.

–Editing by Emily Kokoll and Michael Watanabe.

Article Link: How The Fed’s Rate Hike May Affect Real Estate
Author: Nathan Hale