The commercial real estate market is no stranger to economic cycles. But in recent years, rising interest rates have forced many investors and developers to take a closer look at how they approach financing. What was once a straightforward capital stack now requires more planning, more flexibility, and in some cases, a shift in strategy altogether.
If you’re navigating acquisitions, refinances, or construction deals in today’s market, understanding how interest rates shape your financing options is essential.
Rising Rates, Rising Pressure
When interest rates increase, so do borrowing costs. That’s obvious on the surface, but the ripple effects run deeper.
Higher rates reduce a property’s cash flow after debt service, which in turn puts pressure on debt service coverage ratios (DSCR). That can limit how much leverage lenders are willing to offer. A deal that penciled easily at a 3.5% interest rate might no longer meet lender thresholds at 6.5%, even if the fundamentals haven’t changed.
In many cases, this has translated to:
Lower loan proceeds
Tighter underwriting standards
Greater equity requirements
And for bridge loans or construction debt, pricing has widened even more. Lenders are building in cushions to account for market uncertainty, which further drives up all-in costs.
How Borrowers Are Adapting
For borrowers, rising interest rates haven’t just changed the math — they’ve changed the playbook. Here are a few of the most common ways investors and sponsors are adjusting:
1. Reducing Leverage
Many borrowers are accepting lower loan-to-value (LTV) ratios to keep monthly payments in check and meet DSCR requirements. That means bringing more equity to the table or syndicating a larger portion of the capital stack.
2. Seeking Alternative Financing Sources
There’s been a noticeable uptick in the use of preferred equity, mezzanine debt, and JV equity to fill gaps left by tighter senior debt. These options come at a cost, but they also provide flexibility when traditional bank financing falls short.
3. Focusing on Cash-Flowing Assets
With debt more expensive, value-add or lease-up deals are harder to finance unless they’re deeply discounted. As a result, many borrowers are gravitating toward stabilized assets with in-place cash flow to support higher debt costs from day one.
4. Shorter-Term Loans with Flexibility
Some borrowers are choosing shorter-term loans, often with floating rates, with the goal of refinancing once rates come back down. Others are negotiating interest-only periods to soften early cash flow constraints while repositioning an asset.
Example: Interest Rates in Action
Consider a borrower acquiring a retail property with $600,000 in projected NOI. At a 3.5% interest rate, a lender might be comfortable offering a $7.5 million loan based on DSCR and debt yield standards.
But if rates rise to 6.5%, that same deal may only support a $5.9 million loan, assuming the lender wants to maintain a 1.25x DSCR. That’s a $1.6 million drop in proceeds, not because of the asset itself, but purely due to the cost of capital.
In response, the borrower might reduce the purchase price, bring in a preferred equity partner, or restructure the deal with a mix of senior debt and mezz.
What Lenders Are Watching
From a lender’s perspective, the focus has shifted as well. In a rising rate environment, the emphasis is less on maximum loan size and more on sustainability. Lenders want to see:
Strong, stable cash flow
Conservative pro forma assumptions
Exit strategies that make sense under multiple interest rate scenarios
They’re also paying closer attention to debt yield as a hard floor for sizing loans, especially when DSCR is under pressure from higher rates.
Final Thoughts
Rising interest rates haven’t made CRE financing impossible — they’ve just made it more nuanced. For borrowers who can stay flexible and understand what today’s lenders are looking for, opportunities still exist.
Whether you’re acquiring, refinancing, or repositioning, the key is to structure deals with today’s environment in mind. That might mean accepting more conservative leverage, exploring alternative capital sources, or stress-testing your numbers more carefully than in years past.
If you’re looking at a deal and wondering how higher rates might impact financing options, we’re happy to take a look and walk through potential scenarios.
