High interest rates have devastated commercial real estate markets from 2022-2024. Rampant inflation drove the Federal Reserve to hike interest rates 11 times between early 2022 to mid-2023. After sitting at a range of 0% to 0.25% during the pandemic, the target federal funds rate leaped to 5.25 to 5.5%.
In September and November 2024, the Fed cut the funds rate target range to 4.5 to 4.75%. Where they go from here remains a question for debate and speculation.
Sharply higher interest rates left many commercial property owners with far higher loan payments than they anticipated because many commercial loans come with floating interest rates. That’s left many commercial owners with negative cash flow, which has led to a spike in commercial foreclosures in 2024.
So, what’s the outlook for passive real estate investments entering 2025?
Stubbornly High Rates Would Mean More Carnage to Come
Just two months ago, nearly everyone in the real estate industry assumed that interest rates would drop through the end of 2025. That may not happen. The longer interest rates remain elevated, the more commercial properties will default on their loans and enter foreclosure.
To begin with, higher interest rates mean higher monthly payments for properties with floating-rate debt. If rates stay high, many property owners will continue burning through their cash reserves and ultimately default.
And that says nothing of the properties with loans about to expire. Even many properties with fixed-rate debt will find themselves in deep water if their low-interest loans expire while rates stay high.
This, by the way, is a lot of loans. Nearly $1.2 trillion in commercial property loans are set to expire in 2024 and 2025. Remember, commercial loans tend to have far shorter terms than residential mortgages—typically three to 10 years instead of 15 to 30.
What does all that mean for passive investors?
It spells bad news for existing troubled investments and good news for new investing opportunities. More distressed properties would come on the market, with past investors losing huge amounts of capital. New buyers will be able to score discounted deals on these distressed properties.
In our Co-Investing Club at SparkRental, we keep investing, month in and month out, regardless of what the mood of the market is. Fear and greed make bad investing advisors. We have invested in the “bleakest” moments of the last two years and continue investing now, scoring some great deals along the way.
Interest Rates: Loan Rates, Bonds Yields, and the Fed Funds Rate
When people talk about “interest rates,” they could mean a lot of different things.
Many in real estate talk about interest rates when they really mean loan rates: mortgage rates and commercial loan interest rates.
But when we talk about the Fed changing rates, we actually mean something different. The Fed sets the fed funds rate, which is a benchmark for what banks charge each other for overnight loans. That has a downstream impact on other types of interest rates, but it’s far from the whole story.
Mortgage and other loan rates are far more closely aligned with bond yields. In fact, mortgage lenders typically price loan rates at a premium above bond yields. Higher bond yields drive up loan rates.
And here’s the thing: Bond yields and mortgage rates have actually risen in the two months since the Fed started cutting interest rates.
Rising Bond Yields and Loan Rates Entering 2025
Both before and after the presidential election, bond yields and loan rates have risen. As of Nov. 14, 30-year mortgage rates hit a five-month high of 6.78%.
Why?
First, investors remain worried about inflation. The Consumer Price Index inflation rate rose for the first time since March last month. If inflation isn’t conquered, the Fed may pump the brakes on rate cuts. More on inflation momentarily.
But as touched on, the fed funds rate is not what’s driven bond yields and loan rates higher over the last two months. Bond traders and investors have driven up bond yields since the election out of concern for some of incoming President Trump’s fiscal policies.
Higher government spending can spur bond markets to demand higher yields. Investors fear how ballooning government debt will impact long-term Treasury bonds. And those fears appear grounded: The Committee for a Responsible Federal Budget forecasts President Trump adding $7.75 billion to the national debt over the next decade.
And unchecked government spending brings us right back where we started: inflation.
Inflation Risk Under President Trump
What do tariffs, tax cuts, high government spending, and lower government regulation all share in common?
They’re inflationary.
Don’t get me wrong: I’m not opposed on principle to tax cuts or reevaluating regulation. But they stimulate the economy, and economic stimulus can quickly cross the line into overheating the economy and pumping up inflation.
You don’t have to take my word for it. Bond and derivative traders have started pricing in those inflation fears, currently pricing in a Fed funds rate of 3.75 to 4% by the end of next year rather than the 3.25 to 3.5% target rate previously anticipated by the Fed.
And if anyone expects a smooth and simpatico relationship between Trump and Fed chair Jerome Powell, they have a short memory. Trump has at times claimed he’d try to oust Powell, and since the election, Powell has pushed back that Trump doesn’t have the power to fire him. Some Republicans (and Elon Musk) have gone so far as to call for “ending the Fed” entirely.
The bottom line: If inflation rears back up under Trump’s fiscal policies, the Fed won’t hesitate to raise rates again. That would spell trouble for existing commercial property owners, praying for the reprieve of lower loan rates and cap rates.
Why I Plan to Keep Investing Every Month
Do you know what will happen over the next year? I certainly don’t.
This is why I don’t base my investments on conjectures. I practice dollar-cost averaging in my real estate investments.
Every month, I invest another $5,000 as just one more member of the Co-Investing Club. Last month, it was a private partnership to build a handful of new single-family homes; this month, it’s a medium-term multifamily syndication paying high distributions; next month, it could be a private note or an industrial property or a portfolio of short-term rentals.
Do interest rates affect real estate investments? Absolutely. But I can’t predict them, and neither can you.
What I can do is screen my passive investments for debt risk. We look for investments with plenty of loan term remaining, so the operator won’t be forced to sell or refinance in a bad market. We also look for interest rate protection, whether that’s a fixed rate, a rate cap, a rate swap, or some other mechanism to prevent higher rates from sinking the investment.
And many of the investments that we make just aren’t very impacted by rates. I mentioned that new construction partnership with a spec home developer—short of interest rates skyrocketing over the next year, they just won’t impact our returns. Likewise, we’ve invested in joint ventures to flip houses, a land fund, and other investments that aren’t very sensitive to interest rates.
I’ve written before about why I’ve stopped worrying about what the Fed does. We constantly look for ways to protect against downside risk in our investments, and that includes protecting against interest rate fluctuations.
The Forecast for Passive Real Estate Investments
Will inflation come roaring back? What will the Fed do with interest rates? Will Trump’s policies help or hurt passive real estate investments? How will bond markets and loan rates react to those policies?
I can share my opinion: Interest rates don’t look as likely to fall as they did two months ago. I think it’s too early to declare victory over inflation. But I see so much uncertainty in both financial markets and in which policies Trump will or won’t enact that prognostication feels pointless.
I have no doubt that you have strong opinions about how Trump’s policies will either help or hurt passive real estate investments. You could be spot on—or your own political bias in one way or the other could be skewing your vision.
My top priority remains minimizing downside risk in my real estate investments. I look for investments that will succeed no matter which way the wind blows with interest rates in the next few years.
Beware of inflation and interest rate risk, but don’t stop investing in it. And when in doubt, vet your investments with a community of other investors. I sleep far better at night, having vetted deals alongside dozens of other investors and only having $5,000 to $15,000 tied up in each deal.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
