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The Impact of Lower Interest Rates in Commercial Lending



Interest rates have an obviously large impact on the commercial real estate (CRE) market.  Since the Federal Reserve is now starting to lower rates, let’s dive into what those impacts may look like. 

Improved Affordability for Financing

When interest rates decrease, it becomes more affordable for commercial real estate stakeholders to secure financing for new projects or refinance existing debt. Lower interest rates mean you’ll pay less in interest over the life of the loan, which can significantly enhance your cash flow. It can also mean that the loans that were taken out over the previous 2-3 years might benefit from refinancing, resulting in the volume of commercial lending increasing over previous years.  

Enhanced Cash Flow 

Reducing the expense of debt service due to lower interest rates can lead to improved profitability for investment properties. When your loan payments are smaller, more of your rental income can flow directly into your pocket. This can have an immediate impact on your bottom line.   

Potential Impact on Property Values 

As interest rates drop, cash flow coverage increases. This means that banks need to set aside fewer reserves for potential loan losses. With those extra reserves, they can lend more money, which in turn facilitates more deal flow. Increased liquidity and lower borrowing costs often lead to rising property prices. This gives investors the ability to pull more equity out of their current portfolio to invest elsewhere, driving up demand.   It also can impact new investors who now cannot afford to purchase the building because of increased selling prices.

There are some possible negative impacts to lowering rates for commercial investors.  

Bank Profitability Squeeze 

When rates come down, banks may suffer from reduced interest rate spreads.  This may make banks stricter when underwriting and considering projects they are willing to invest in since the profitability for transactions going forward will be less.  The line that banks draw regarding the deals they are interested in versus taking a pass is in a constant state of flux, and the amount of earnings they will receive is an item that moves that line.  That will push some projects to non-bank lenders, who have a large presence in the commercial lending market, however their rates and terms are usually less attractive than conventional bank financing.  

Rising Losses on Commercial Real Estate loans 

As stated above, when interest rates drop banks find it difficult to maintain profitability.  As rates decline, their net margin shrinks.  Stricter lending standards may make banks more cautious about the amount of exposure they want to take on new deals.  With the higher financing costs since the beginning of the cycle, rising losses of CRE loans currently on the books is a potential outcome.  

Remember, though, that the full extent of these outcomes depends on various factors, including the overall economic climate and the Federal Reserve’s monetary policy. It’s essential for investors and lenders to stay informed and adapt their strategies accordingly. 


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