A constant give and take. An aspect of business that’s always just overhead. And in the past couple of years, a thorn in the real estate world’s side. Yes, we’re talking about interest rates.
For now, interest rates are holding fairly steady — they’re just a little higher than buyers want to see.
“Everyone knows that the Federal Reserve has steadily raised interest rates over the past 18 months, said Marcus Guinn, executive vice president and loan manager at Arvest Bank-Central Arkansas. “The prime lending rate is currently 8.5%. To put that in perspective, compare that to two years ago, when the prime rate was 3.25%. So this increase in interest rates for many customers — particularly those in the commercial real estate space who are in the development or an investment property business — will significantly impact the cash flow of these investment projects.”
When the cost of borrowing money rises, activity slows. Paired with the staggering inflation rates over the past couple of years, the construction of projects hasn’t been smooth sailing.
“What we’ve seen with inflation — construction costs increase significantly. The cost to build is as high as I’ve ever seen it,” said Scott Dews, market president for First Security Bank in Hot Springs. “When you couple that with an 8.5% prime, [for] most borrowers, you’d probably see a 9% interest rate right now. So increased construction costs and 9% cost of borrowing, that really did slow down new construction commercially.”
During periods of high interest, projects slow and may even come to a halt. As loans come up for renewal and rates reset, some buyers might be forced to become sellers if they are over-collateralized. So it’s important to evaluate liquidity and how current rates, along with possible rate changes, can impact an upcoming project.
“If I were in the market for investment property… and my loan was going to cost me 8.5% today versus 3.25% two years ago, I might decide that ‘You know what, I’m going to pay too much more for the loan today.’ So I might decide to sit on the sidelines and just wait until rates return to where I think it’s more of a normalized rate. And that’s what we are starting to see some customers do, actually,” said Guinn. “They are taking that wait-and-see approach because the Fed has signaled at its last meeting that they would begin to lower rates [in 2024].”
While Guinn is seeing buyers attempting to wait out the rates, Dews has begun to see a few jumping back in.
According to Dews some of the more experienced investors see high interest rates as less of an obstacle and more as a window of opportunity.
“They can capitalize on distressed asset sales, maybe negotiate more favorable terms with motivated sellers,” said Dews.
Whether jumping back in and taking the 8.5% by the horns or taking the wait-and-see approach, it’s safe to say that things are evening out for now, and it won’t be long before the market sees a small bit of relief.
“The reality is that current rates are not that high from a historical standpoint,” said Guinn. I have been fortunate to be a lender for about 37 years, so I have seen interest rates back in the ‘80s that were in the 14-15% range. It’s all relative.”