Hedging Rising Interest Rates for CRE Investors

The Federal Reserve has raised interest rates 11 times since last year — the fastest pace of tightening since the early 1980s. As interest rates continue to rise, it’s important for investors to keep an eye on these shifts and consider the potential impacts on their returns. Read ahead to learn about interest rate hedging so that you can prepare to protect your assets while navigating this unpredictable market.

How Does Interest Rate Hedging Relate to CRE?

Historically, commercial real estate (CRE) is an asset used not only for portfolio diversification but also to hedge against inflation and minimize risks. Commercial real estate is often used for hedging because property values tend to increase along with inflation. Plus, property owners can increase rents to offset rising prices. Investors can use interest rate hedging to reduce and control their exposure to risks in an ever-changing market.

What Do Higher Interest Rates Mean for Investors?

Nearly all commercial real estate is purchased using some combination of debt and equity. Therefore, rising interest rates can dramatically impact the cost of commercial properties. In short, as the cost of capital rises, it becomes more expensive to own and invest in real estate.

Amidst rising rates, some investors fear that capitalization rates and operational costs will rise while property values decrease. In turn, this could mean that properties will produce lower returns. Factor in increasing borrowing costs and higher vacancy rates, and the potential impacts of higher interest rates on investors are clear.

How Can CRE Investors Hedge Against Rising Interest Rates?

For investors worried about how economic shifts will impact their portfolios, CRE investments can be a great hedge against the effects of inflation and rising interest rates. One method CRE investors can use to hedge against rising interest rates are interest rate caps. An interest rate cap is a limit on how high an interest rate can rise on variable rate debt. A higher cap rate means that the market judges the property to have more risk, which means that investors need to earn a higher rate of return. For investors, an interest rate cap guarantees investment risks are at a minimum, even in a fluctuating market.

Alternatively, you can consider an interest rate swap; this is an agreement between two parties to exchange one stream of interest payments for another, over a set period of time. Because forward-thinking investors value risk mitigation, interest rate swaps are a suitable means to minimize risks associated with macroeconomic conditions – regardless of interest rate fluctuations.

Want to learn more?

An advisor, like Thirty Capital Financial, can provide you with tools and custom solutions for interest rate risk management by using strategies that take into consideration your risk tolerance and the current market trends. Whether it’s risk on current floating-rate debt, refinance risk on fixed-rate debt, or risk on prepayment penalties, an experienced advisor can help you manage the interest rate risk associated with that debt through consultations and strategic portfolio planning.

About Thirty Capital Financial

Thirty Capital Financial is a leading service provider to the commercial real estate industry. Our team of advisors have spent decades providing solutions for defeasance, interest rate hedging, and debt management. With our personalized approach, we provide you with the tools, solutions, and strategies to confidently manage debt while supporting the growth of your company. Contact us today to speak with an expert defeasance consultant!