How Inflation and Interest Rates Impact Commercial Real Estate

Understanding inflation and interest rates is crucial for investors, tenants and developers in today’s economic environment. Rising inflation often leads to higher interest rates, and both can significantly affect the performance of commercial real estate. Because economic conditions are cyclical, staying informed helps all parties navigate changes more effectively. Here’s an outline of how inflation and interest rates impact commercial real estate:

What Is Inflation and How Does It Affect Commercial Real Estate?

Inflation is defined as an increase in the prices of goods and services. It can be caused by factors like supply chain issues, labor shortages, and monetary policy. As inflation rises, purchasing power decreases across industries.

In commercial real estate, inflation impacts:

• Construction and operating costs – Materials, labor, and development costs increase.
  
• Rent and lease adjustments – Leases tied to the Consumer Price Index (CPI) or operating expenses often rise with inflation.
  
• Valuation shifts – Changes in income and expenses may affect property appraisals.
  
• Tenant challenges – Small businesses may feel financial strain, increasing vacancy risks.
  

What Are Interest Rates and How Do They Impact Commercial Real Estate?

Interest rates refer to the percentage a lender charges over a specific period of a loan. The Federal Reserve controls the federal funds rate—the rate banks use to lend reserves to each other overnight—which influences other interest rates in the economy.

This rate is used to manage inflation and promote economic stability. When interest rates are high:

• Borrowing slows, reducing lending and overall economic activity.
  
• Mortgage rates and loan terms become less favorable.
  
• Cap rates tend to rise, often decreasing property values.
  
• Investors become more conservative, seeking lower-risk opportunities.
  
• Development slows, as financing becomes more difficult to secure.
  

Opportunities in a High-Inflation, High-Interest Environment

Even in uncertain times, commercial real estate offers opportunity. Real estate is a historically strong hedge against inflation. Certain asset classes—like industrial, multifamily, and essential retail—tend to perform well.

Financing is available for commercial real estate transactions, and investors can seek out creative financing options, such as:

• Seller financing
  
• Interest-only loans
  
• Private equity solutions

Investors may benefit by locking in fixed-rate loans and focusing on value-add or stabilized assets. Tenants may consider negotiating long-term leases now and evaluating their total occupancy costs.

Working with a trusted commercial real estate advisor is recommended when navigating these challenges.

Economic conditions continue to evolve, and both inflation and interest rates play a major role in shaping the commercial real estate landscape. It’s important to stay informed and proactive. Contact your commercial real estate advisor to evaluate opportunities in today’s market.