Plenty of investors struck agreements earlier this year when loans were cheaper, only to watch financing costs jump. Now they are coming back to the table asking for price reductions or other givebacks before closing. That behavior surfaced as bond yields turned higher in late summer, then grew more frequent after the Federal Reserve bumped its policy rate up by 0.25 percentage point and indicated that further increases could follow.
"Rates went up, what, just a few days ago and I'm already getting calls where they're talking retrade," said Jeff Powers, managing director at Cushman & Wakefield. With the usual six to 12 months between signing and closing, rapid rate moves can meaningfully change a buyer's math.
Eastham Capital had struck a deal to purchase a roughly 200-unit apartment complex in the Midwest for about $20 million. Founder and managing director Matt Rosenthal said that, before the deposit went in, borrowing costs rose by over 0.6 percentage point. Eastham threatened to walk and won a $600,000 price cut. "It's certainly a different deal now," Rosenthal said.
In June, a buyer was secured by Medalist Diversified for a retail site in Greenville, S.C., measuring 65,000 square feet and priced at roughly $10.2 million. As rates rose over the summer, the buyer pushed for a discount. After back-and-forth, Medalist trimmed the price by $100,000, and the sale closed in September "due to the potential impact of the interest rate environment," said Chief Financial Officer C. Brent Winn Jr.
Lenders are flinching too. One bank involved in a $45 million construction financing for a retail center in North Carolina that was more than 90% leased pulled out due to market conditions. Marcus & Millichap found a replacement. "We are working harder to close deals now than we ever have before," said Bobby Werhane, a managing director at the firm. "There's just much more friction in the market."
Renegotiated deals are an early sign a property market is turning. Market Briefs covers commercial real estate free every weekday.
Commercial real estate had been making headway as new supply eased, more employees returned to offices, and borrowing costs steadied. Earlier this year, many expected the Fed to cut rates, which helped lift values as debt costs fell and bond yields declined, making property yields look more attractive. The sudden jump in rates is cutting that recovery short. From late August through Friday, as rates jumped, the FTSE Nareit All Equity REITs Index dropped over 8%, and the S&P 500 advanced 1%, per Green Street.
The hit is not limited to landlords. Lower values and thinner deal flow trim property-tax and transfer-tax revenue, while higher financing costs make it tougher for developers to hit their return hurdles. That, in turn, reduces the need for construction labor, architects, and materials. "The hurdle is simply higher," said Alfonso Munk, a co-head overseeing investment management at Hines, which is based in Houston.
Few sectors are as rate sensitive as commercial real estate, where buyers typically use a small slice of equity and finance the rest. Outstanding commercial and multifamily real-estate mortgages total more than $5 trillion. That sum exceeds what Americans owe on credit cards and auto loans combined.
As loans made when money was cheaper reach maturity, some owners cannot refinance or repay and are slipping into distress. Trepp reports that in August, 11.42% of mortgages bundled into commercial mortgage-backed securities were with special servicers, the highest share since February 2013.
There is a counterweight. Lenders and investment funds still have plenty of capital, and they have raised it faster than deal activity has supplied opportunities, which is fueling a scramble among lenders to finance the most resilient projects. Northwind Group, a New York lender, recently issued a first mortgage of $208 million to turn a 355,000-square-foot Brooklyn office tower largely into apartments. Founder and managing partner Ran Eliasaf said banks and private lenders vied for the business. He added that higher rates have lifted loan pricing and pushed valuations to be more conservative, but the shift "hasn't changed the ability for borrowers to obtain loans." In his words, "It's a very deep, liquid market right now."
What this means for your money: expect longer negotiations, more chiseled pricing, and higher loan pricing and more conservative valuations to filter into returns. If you have exposure to property funds, REITs, or private deals, watch maturities, special-servicing trends, and how quickly transactions actually close. That is where the real stress or resilience will show up.
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