How Higher Rates Are Reshuffling CRE’s Financing Deck

The playing field for commercial real estate is shifting dramatically. A combination of geopolitical conflict, rising energy costs, inflation, rising levels of government debt and the pending midterm election is generating pressure on benchmarks and fueling market uncertainty. At the same time, strong performance from the stock market, resilient consumers, stable employment and investment in the rapid expansion of AI have balanced the impacts of the former with sustained economic momentum.

All this makes for interesting times. Commercial real estate does not live in a vacuum. Deals refinancing or trading into a higher rate climate are feeling the stressors. Transaction pricing is fluid. Here are some key themes worth reviewing as we chart a course to close out 2026 and enter 2027.

Debt markets remain flush

Let’s start here on the positive notes. The difference between the current market challenges and previous disrupted cycles (GFC, Tech Wreck, etc.) is ready access to abundant debt liquidity remains strong. Borrowers have a full slate of options from a wide spectrum of lenders to consider when aligning debt to optimize their financing to market conditions and investment goals. Banks, agencies, insurance companies, CMBS, debt fund, credit union and private capital sources are all active, competing and ready to lend. The recommendation? Stay connected to relationship intermediaries who are in the market every day uncovering the best overall lending opportunities. During volatile times in the capital markets, relationships and track record are key!

Economic performance remains resilient

The stock market is soaring. AI investment is fueling job growth and infrastructure investment. Employment is tight and holding in a historically low range. Office is on the mend and making a comeback with lenders. Key markets are performing above or at least to expectations. Several years ago, many had written San Francisco off. Today, it has one of the healthiest office and residential markets in the nation. Business-friendly states like Texas, Florida and Tennessee continue to attract new corporate investment and work their way through a supply overload of new multifamily. Approvals for the Paramount/Warner Bros. merger has kept a major entertainment player in California. While pressures and uncertainty remain, economic fundamentals continue to support asset performance, which in turn supports underwriting.

Persistent rate volatility

Rate volatility is once again the headline risk. The playing field has dramatically shifted and upward pressure on key benchmarks is redefining “higher for longer” once again. Expect we will remain in this new range for the foreseeable future. We may even see further increases before we get to the other side. Treasury yields have climbed significantly. SOFR is feeling pressure from the recent 25-basis-point increase to the Federal Funds rate, with expectations that we will see further Fed rate increases later this year or early next. However, these new rates are not the full story and, while not in the low, low range of the recent cycle, still manageable for the time being and by historic standards.

Realistic expectations required

For conservative borrowers refinancing amortized loans on stabilized properties that have seen reasonable rent growth, performance continues to generate cash-neutral solutions for new debt even in this higher range. The deal may generate little or no cash proceeds, but it will not require new equity. Interest-only maturities with rent growth can also potentially meet the necessary DSCR for new debt. Property sales will require some new price discovery. Basis resets will bring these assets into alignment for today’s cost of capital. Some of these resets will be compelled. Others will be chosen to generate a necessary exit. For borrowers who pushed leverage in a lower interest rate climate or were unable to capture the projected value-add momentum during the post pandemic run up, sales with short pays or even foreclosures will reset basis in these properties. Rate conditions are challenging, but deals are still getting done.

Equity as a resource

For many assets refinancing or repricing into the current market dynamic, fresh or increased equity may be required to reset loans to meet today’s minimum DSCR/debt yields. Finding fresh equity may be more of challenge in this cycle. Many of the major houses are resetting their portfolios to manage defaults, meet capital calls or mark to market accounting requirements and JV and LP partners are becoming more selective in deploying their capital. However, we are seeing an abundance of opportunities to take on preferred equity and some lenders have dusted off their participation programs, where after a first note they will add a participating allocation to function as equity disguised as debt in a secondary position to heighten yield and share in performance. The benefit of this participation strategy is it offers a tax benefit traditional equity structures do not. And where performance and value-add projections warrant, debt funds are ready and willing to come on board in a traditional mezzanine format.

Pain and opportunity

One of the things to remember about uncertainty and disrupted markets is that someone’s pain can become another’s opportunity. Real estate has always been seen as a hedge against inflation and continues to be. That appeal continues to resonate. Investors with significant capital on the sidelines planned for targeting distressed assets may finally have their day moving into 2027 and are looking to deploy into new deals. For highly leveraged assets refinancing into this higher rate climate, expect to see the white flags come out more frequently. Sponsors will have to make hard choices. More money in or sell. Lenders will move to sell challenged loans and buyers will look to leverage opportunities, employing loan-to-own or acquire-at-a-discount strategies to capture new value at a revised basis.

Midterm volatility

One compelling uncertainty on investors’ minds is the upcoming midterm elections and what the outcome may mean for 2027. Bond markets could become increasingly volatile as investors adjust to the shifting political and fiscal landscape. With control of at least one chamber of Congress potentially changing hands, we should be prepared for greater political gridlock and increasingly adversarial policymaking in the year ahead.

Regardless of where you stand on the political spectrum, one issue is becoming increasingly difficult to ignore: The federal government is highly leveraged, and rising Treasury yields are making the cost of continued borrowing increasingly burdensome. Material increases in government spending, particularly if accompanied by policies that add to the deficit, could place further pressure on an already strained Treasury market.

Even if today’s geopolitical conflicts ease and global energy supplies improve, the bond market may continue to demand a price for persistent deficits, increased borrowing and stubborn inflation. That could keep longer-term interest rates elevated even as other inflationary pressures begin to subside.

Whatever government emerges, the message from many of the bond market’s leading voices seems to be growing louder: Meaningful fiscal restraint will be necessary to create the conditions for a sustainable recovery in interest rates. Hopefully, the political will to pursue meaningful reform can become a bipartisan goal moving forward.

George Mitsanas is principal with Gantry.

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