How Interest Rates Affect Commercial Real Estate Deals

January 2026

Interest rates influence nearly every aspect of commercial real estate investing. They affect how properties are priced, how deals are financed, how much cash flow is generated, and what outcomes look like at exit. For passive investors, understanding these relationships is more important than predicting where rates will go next.

This article explains how interest rates affect commercial real estate deals and how LPs should evaluate rate exposure when reviewing syndications.

Interest Rates and Property Pricing

Interest rates influence what buyers are willing to pay for income-producing assets.

When rates rise:

  • Borrowing costs increase

  • Buyers require higher yields

  • Pricing pressure often increases

When rates fall:

  • Debt becomes cheaper

  • Buyers can support higher prices

  • Competition for assets tends to increase

This relationship is not mechanical or immediate, but over time interest rates are a key input into real estate pricing.

(For valuation context, see Understanding Cap Rates (Without Overcomplicating It).)

The Connection Between Interest Rates and Cap Rates

Interest rates and cap rates are related, but they are not the same thing.

Cap rates reflect:

  • Income relative to price

  • Market risk and liquidity

  • Investor expectations

Interest rates influence cap rates indirectly by affecting:

  • Required returns

  • Financing costs

  • Buyer demand

In practice, cap rates tend to adjust more slowly than interest rates, which can create periods of pricing uncertainty.

Interest Rates and Leverage

Leverage magnifies the impact of interest rates on deals.

Higher rates can:

  • Increase debt service

  • Reduce cash flow

  • Lower debt service coverage

  • Constrain refinancing options

Lower rates can:

  • Improve cash flow

  • Support higher leverage

  • Increase refinancing flexibility

This is why understanding rate sensitivity is critical when evaluating leveraged real estate investments.

(For leverage mechanics, see Understanding Leverage in Real Estate Syndications.)

Fixed vs Floating Rate Exposure

Interest rate risk depends heavily on loan structure.

Fixed-rate debt:

  • Provides payment predictability

  • Reduces near-term rate risk

  • May limit flexibility in certain scenarios

Floating-rate debt:

  • Can offer lower initial rates

  • Introduces exposure to rate increases

  • Often requires interest rate caps or hedges

Neither structure is inherently good or bad. What matters is whether rate exposure is understood, sized appropriately, and stress-tested.

Impact on Cash Flow and Underwriting

Interest rates affect cash flow both directly and indirectly.

In higher-rate environments – or when rates are expected to remain elevated or rise further:

  • Debt service consumes more income

  • Margin for error narrows

  • Conservative underwriting becomes more important

This is why disciplined underwriting focuses on:

  • Strong debt service coverage

  • Viability without favorable refinancing

  • Sensitivity to higher-rate scenarios

(For underwriting context, see Financing & Underwriting Basics.)

What LPs Should Evaluate (So What?)

Understanding rate mechanics is only useful if it informs better decisions.

When rates rise or are expected to remain higher:

  • Stress test DSCR at higher interest levels

  • Check breakeven occupancy

  • Evaluate refinance assumptions for realism

  • Consider whether NOI growth meaningfully offsets rate pressure

  • Be cautious of floating-rate exposure

When rates fall or are expected to decline:

  • Look for refinance opportunities that improve returns

  • Assess whether exit cap assumptions reflect tailwinds

  • Understand how cash flow could expand post-renovation

These questions help LPs focus on resilience rather than forecasts.

The Real Message for LPs: Debt Strategy Matters

Interest rates themselves are outside an investor’s control. Debt strategy is not.

More disciplined operators tend to focus on:

  • Lower leverage during uncertain environments

  • Fixed-rate or properly hedged debt for value-add timelines

  • Conservative refinance assumptions

  • Healthy DSCR cushions

  • Sensitivity analysis across +100 to +200 basis point scenarios

This approach does not eliminate rate risk, but it reduces the chance that rate changes force poor decisions.

Final Takeaway

Interest rates shape the risk, cash flow, valuation, and exit profile of a deal.

For LPs, the focus should be on:

  1. The structure of the debt

  2. The operator’s ability to manage rate volatility

  3. Assumptions tied to refinancing and exit

  4. How rate changes interact with the business plan and asset type

Returns are not just about what the operator does – but about the rate environment they are operating in and how the deal is structured to handle it.

Note: This material is for educational purposes only and is not intended as tax, legal, or investment advice. Investors should consult appropriate professionals regarding their specific circumstances.

Continue Learning

This article is part of a broader learning series on passive real estate investing.

→ Start from the beginning here: Passive Real Estate Investing Learning Guide

→ Next recommended read: How to Read a Pro Forma: The 8 Numbers That Actually Matter

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