Key Takeaways
- Interest rates set the cost of leverage. A 1% change can swing annual debt service by $15K–$25K on a typical multifamily deal
- Lenders care about DSCR (debt service coverage ratio) above everything else. Below 1.25x, most deals don't get financed
- When rates are rising, value-add operators who can push NOI still hit strong returns despite the higher cost of borrowing
- Locking in fixed-rate debt during the hold period takes refinancing risk off the table and gives investors predictable cash flow
Every time the Fed makes a move, the same questions come up. "Should we still be buying?" "Should we wait for rates to come down?" "Is commercial real estate going to crash?" These are reasonable questions. But the relationship between interest rates and real estate value is more nuanced than the headlines suggest.
The Direct Effect: Borrowing Costs
This part is straightforward. When rates go up, debt costs more. On a $2 million acquisition with 75% leverage, the difference between a 5% and 7% interest rate is roughly $30,000 a year in additional debt service. On a small multifamily deal, that comes straight out of cash flow and return. It's a real cost, and it's not trivial.
But the important nuance: deals have worked in both low-rate and higher-rate environments. In a low-rate world, everyone can afford to bid aggressively and cap rates compress. In a higher-rate world, fewer buyers show up, pricing resets, and operators who can execute still find solid deals. The math shifts, but it does not break.
Worked Example: How Rates Affect DSCR
20-unit building, NOI: $160,000. Loan: $1,350,000 (67.5% LTV on $2M purchase).
At 5.0% rate (30-yr am): Annual debt service = $86,976
DSCR = $160,000 ÷ $86,976 = 1.84×
At 6.5% rate (30-yr am): Annual debt service = $102,372
DSCR = $160,000 ÷ $102,372 = 1.56×
At 7.5% rate (30-yr am): Annual debt service = $113,220
DSCR = $160,000 ÷ $113,220 = 1.41×
Most lenders require 1.25× DSCR minimum. Even at 7.5%, a conservatively leveraged deal still clears the threshold — but the margin for error shrinks significantly.
| Scenario | LTV | Rate | Annual Debt Service | DSCR | Cash-on-Cash |
|---|---|---|---|---|---|
| Conservative / Higher Rate | 65% | 7.0% | $103,560 | 1.54× | 8.1% |
| Moderate | 70% | 6.0% | $100,632 | 1.59× | 9.9% |
| Aggressive / Lower Rate | 75% | 5.0% | $96,636 | 1.66× | 12.7% |
| Overleveraged / Higher Rate | 80% | 7.0% | $127,344 | 1.26× | 8.2% |
Hypothetical scenarios on a $2M acquisition, $160K NOI, 30-year amortization. Illustrative only — actual terms vary by lender and borrower.
Cap Rates: Not Just a Rate Function
People assume cap rates move in lockstep with interest rates. They don't. Cap rates are influenced by rates, but they're also influenced by supply and demand, rent growth expectations, asset quality, and investor sentiment. We've seen periods where rates rose and cap rates held steady because demand for the asset class was strong enough to absorb the rate increase.
Waiting for the perfect rate environment is a good way to never buy anything. The best deals are not made because rates are low — they are made because the operator found the right property at the right price.
In the workforce housing segment — the $1,200 to $1,800 rent range — cap rates have been remarkably stable even through the 2022–2024 rate cycle. Why? Because the underlying demand is structural. People need affordable apartments regardless of what the Fed funds rate is. That demand floor supports values even when the cost of capital increases.
The Refinance Question
Where rates really bite is on the refinance side. Operators who bought at peak prices with short-term bridge debt and planned to refinance into permanent financing at 3.5% are facing a different reality at 6.5%. Some of these deals don't cash flow at the new rate. Others need to be recapitalized. This is a real problem in the market — but it's mostly concentrated in deals that were overleveraged or overpriced to begin with.
We've always been conservative on leverage. We don't stretch to 80% LTV on bridge debt hoping rates drop by the refinance date. We typically finance at 65–70% and make sure the deal cash flows at current rates on day one. If rates come down and we can refinance at better terms, that's gravy. But we don't need it for the deal to work.
The Approach That Works
The disciplined approach does not change dramatically based on the rate environment: buy garden-style walkups that need renovation, underwrite to current rates, build renovation budgets from real cost data. What changes is the competitive dynamic: in a higher-rate environment, fewer buyers are competing for the same deals, which means better pricing for operators who can still execute.
The operators who thrive in any rate environment are the ones whose returns are not solely dependent on leverage and financial engineering. If value creation comes from physical improvement of the asset — fixing the roof, updating units, reducing insurance costs, improving management — then rates affect the return but do not determine it.