How Rising Interest Rates Are Impacting Commercial Real Estate Development
Rising interest rates have become a driving force in commercial real estate (CRE) development, changing financing approaches, investment, and project viability in the sector. As lending expenses rise, developers face new obstacles that demand out-of-the-box thinking in order to move development forward. Where some sectors have stalled under stricter credit, others have adjusted through changing approaches and alternative sources of funding.
Dov Hertz, a long-time real estate developer, offers insights into how rising interest rates are transforming commercial real estate development and what investors can anticipate in years to come.
Increased Borrowing Costs and Project Viability
Perhaps one of the most direct and profound consequences of rising interest rates is increased borrowing expenses. Higher interest rates make it costly for developers to fund new development, and many must re-evaluate the financial viability of development deals.
“When interest rates were low, developers could lend at a fraction of current expense,” according to Dov Hertz. “Now, every development necessitates a much deeper examination of financing structures, cost savings, and potential yield. Some deals that panned out a year ago simply don’t work any longer.”
Many developers have delayed or canceled spec development that is financed-dependent, particularly in property types such as offices, whose demand is uncertain. Instead, they’re prioritizing development with strong pre-leasing activity or secure incomes, such as industrial, multi-family, and medical buildings.
Adjustments in Investment Strategies
With traditional financing growing increasingly costly, investors and developers are changing gears. Institutional investors, private equity companies, and real estate funds are increasingly providing alternative financing options. Many developers, too, are venturing into joint ventures and partnerships to divide financial burden.
“We’re seeing a significant move towards alternative sources of capital,” Hertz describes. “Developers are working with private lenders, institutional investors, and structured financing in a larger role to move deals forward. Alternative structures for deals become critical in a high-rate environment.”
In a few instances, cashed-up investors are taking advantage of the changing marketplace and buying in at a bargain, buying assets in disrepair at a discount, and financing deals at a better price. Developers with strong networks in private lending are discovering opportunities that traditional bank financing can no longer fund.
The Future of Commercial Real Estate Development
Some commercial real estate sectors, in fact, defy current headwinds in rising interest rates. Industrial real estate, fueled by nearshoring and growing demand for e-commerce, continues to be in strong demand. Multifamily development holds its ground, with housing shortages in many markets driving ongoing investment.
“Commercial real estate consistently shifts with economic trends,” Hertz observes. “Although rising interest rates have stalled a few deals, they’re creating new opportunities for developers who can adapt. It’s a matter of knowing fundamentals in a marketplace and being smart about when and where and in what manner to make an investment.”
In the future, developers will have to prioritize efficient, cost-effective designs, value-engineering options, and environmentally friendly development techniques in an attempt to counteract financial strain. As inflation steadies and interest rates normalize in the future, well-placed deals will enjoy pent-up demand and a less competitive development environment.
Conclusion
Rising interest rates have ushered in a new era of commercial real estate development, one that will require a calculated and flexible response. Higher lending costs present a challenge while simultaneously enabling new financing, sound investment, and opportunities for well-funded developers to capitalize.
“This is a period of recalibration for the industry,” Dov Hertz describes it. “Developers who understand the new financial environment and react in kind will become even more powerful, positioned to capitalize when times improve.”
Although uncertainty abounds, commercial real estate development continues to evolve, and adaptability and planning become key in overcoming downturns in the economy.
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