Commercial real estate buyers demand price cuts as rates rise

Commercial real estate investors are demanding price reductions or other concessions from sellers as mounting interest rates alter the economics of deals. Investors who secured purchase prices earlier this year, when borrowing costs were lower, are now seeking adjustments before finalizing transactions. The pressure on deals intensified after bond yields started climbing in late summer and accelerated after the Federal Reserve raised its key rate by 0.25% last month, signaling further increases.

The typical six to 12-month gap between signing a contract and closing a sale can result in significant financing cost discrepancies as borrowing rates surge. Jeff Powers, a managing director at Cushman & Wakefield, reported receiving repeated inquiries about renegotiating terms after rates increased within just a few days.

Eastham Capital's purchase of a 200-unit apartment complex in the Midwest exemplifies the issue. The firm had agreed to pay $20 million for the property, but borrowing costs jumped by over 0.6 percentage points before the deposit was due. To resolve the situation, Matt Rosenthal, the firm's founder, threatened to walk away and succeeded in negotiating a $600,000 price reduction.

Bobby Werhane, a managing director at Marcus & Millichap's IPA Capital Markets division, acknowledged that deals are now being closed with greater effort compared to previous experiences. Commercial and multifamily real estate mortgages surpass $5 trillion in total, exceeding combined credit card and auto loan debt levels in the United States.

Following a sharp rise in rates since late August, the FTSE Nareit All Equity REITs Index dropped more than 8%, while the S&P 500 rose by 1% from late August to Friday. Trepp data showed that in August, 11.42% of mortgages packaged into commercial mortgage-backed securities were managed by special servicers, the highest rate since February 2013.

For instance, Medalist Diversified agreed to sell a 65,000-square-foot retail property in South Carolina for $10.2 million after the buyer sought a $100,000 price reduction due to the evolving interest rate environment. The deal closed in September. A bank withdrew from a $45 million construction loan for a retail center in North Carolina due to market conditions, but Marcus & Millichap found an alternative lender. The heightened friction in the market is attributed to the changing interest rate landscape.