Evaluating Interest Rate Spikes in 2022 | How Do Rising Interest Rates Impact Your Property Value?

September 28, 2022

Navigating an Unprecedented Economic Climate

Adjustments in market trends are beginning to impact critical decisions for owners and investors across the country. The nation continues to recover from the COVID-19 pandemic, which is driving economic shifts in the commercial real estate sector. Inflation is climbing at a historic rate. The commercial real estate industry benefited from strong valuation growth due in part to falling interest rates over the last two years, but what do rising interest rates mean as the economy shifts back to pre-pandemic levels? It is a critical time to evaluate and strategize your position in the market. Below are some key factors that can help investors shape a realistic outlook moving forward. 

Historically, Commerical Real Estate Has Been One of the Best Hedges Against Inflation

Historically, CRE has been one of the best hedges against inflation, making it one of the best assets to own. However, just like with every investment vehicle, it’s crucial to take a long-term time horizon. Below are some of the most significant points owners must consider with record inflation in the current market. 

  •  As indicated by the visual below, our economy is currently witnessing the highest inflation rate in roughly 40 years.
  • Record-setting inflation is driving the spike in interest rates, and the current economic climate is validating that surge 
  • The increased cost of borrowing money is pushing capitalization rates up, thus putting downward pressure on property valuations
  • Properties with shorter-term duration leases tend to perform

It is critical to make the best decision for the well-being of your investment portfolio. Our experts have decades of experience navigating all market conditions. Strategize with us to maximize the value of your investment. 

The 10-Year Treasury and Capitalization Rates

The historical correlation between interest rates and cap rates cannot be underestimated. It’s key for self-storage owners to revisit this correlation. Below are some critical evaluation points:

 

  • Capitalization rates trail interest rates, and the spread narrows or widens depending on the status of the market 
  • As the cost of borrowing money increases, capitalization rates increase as well 
  • While the correlation between cap rates and interest rates are not totally linear, all signs indicate that interest rates will continue to increase for the foreseeable future 

 

 

If you are considering selling now or anytime in the next several years, now is the time to capitalize on your investment. Our experts conduct a proprietary 252-point transaction process, which is guaranteed to maximize the value of each asset, regardless of market conditions. 

Potential Risks of Holding an Asset When Interest Rates are Rising

What is the biggest risk of holding during a significant market shift? We believe that the rise in capitalization rates can drastically change the long-term value tied to each asset. We’ve highlighted the critical facts to consider below. 

  • When cap rates are elevated, the net operating income of each asset subsequently needs to be raised to maintain property value 
  •  Navigating the current climate is based around each owner’s ability to significantly increase the net operating income of their asset to fully offset any eroding value caused by rising cap rates 
  • The Bottom Line for Owners: Is the time and effort of raising your NOI to meet rising capitalization rates over the next several years a viable approach for your investment? Owners should take a close look at the current market conditions and evaluate the time and cost of increasing their net operating income to match rising cap rates
Critical Note: For perspective, our experts believe that if the market continues to experience inflation, and cap rates increase by .25 percent, then the net operating income of an asset will need to increase by 5 percent to maintain the current value. If cap rates were to increase by .5 percent, then the NOI will need to increase by 10 percent to maintain current value, and so forth. The chart below illustrates this premise under current market conditions.

Future Cap Rate Implications

*Below assumes the sample asset is valued at $10,000,000 in the current market, as cap rates continue to rise.

For More Information

To discuss the best plan of action for your asset, please reach out to our experts for a confidential discussion. We look forward to helping you reach your ultimate goals. 

*Note: All visual data numbers in this article were derived courtesy of The CoStar Group.