Negative Leverage in Commercial Real Estate
Here is a summary about Negative leverage in commercial real estate: Most investors and developers seek positive leverage with commercial real estate. Now that interest rates are rising, negative leverage is coming back into play. What is negative leverage? It is caused when the Cap rate is lower than the cost of money. As an example if a property is running at a 5 cap and interest rates are 6.5%, that is a negative leverage scenario.
Positive Leverage VS Negative Leverage
Positive leverage would be just the opposite. An example is the cap rate is higher than the cost of money. So a cap rate of 5 when the interest rate is 3% is a positive leverage situation. Positive leverage increases cash on cash returns, negative is the inverse for cash on cash. Cash on cash return or return on the investor’s equity is not a goal in commercial real estate.
Interest Rates
The lower cash on cash returns is starting to happen more frequently as of June 2022. 10-yr Treasuries are at 3% up from 1.48% only 1 year ago. Firms or investors that signed a purchase contract at a low cap rate are being taken by surprise. They now have a situation where the interest rates are higher than the cap rate of the property. Goals and incentives for investors are:
- High Cash on Cash returns
- Leveraging equity
- Using positive levering in a CRE investment
Still buying Commercial Real Estate Assets
Reasons for purchasing in this environment?
- Capital needs to be placed
- Forecast of rent to increase in the market
- Protection against inflation
Shire Commercial has helped clients find suitable investment solutions since 2004. The near term message for Austin for 2022 is, expect lower cash on cash returns for the rest of 2022 and moving forward for the next year. Contact Shire Commercial!