Picture a $2 million single-tenant Starbucks, bought several years ago at a 5% cap rate. The lease is solid, the tenant pays on time, and when the debt was financed at 2% or 3%, the math looked great. Now that loan is coming due, and the new rate on the table is 7% or 8%. Nothing about the building has changed. Everything about the deal has.
That scenario came up during a recent Scholar Big Picture session in front of our live studio audience, and it is one I think investors and business owners should be paying more attention to. A few years ago, the commercial real estate refinancing wall was all anyone wanted to discuss. Today it barely comes up. The problem did not go away. People just stopped talking about it.
The Loans Are Still Coming Due
Commercial real estate debt usually carries terms of ten to fifteen years. That means a large wave of properties purchased or refinanced during the low-rate years is still working its way toward maturity. Those owners have not paid off their loans. They have to refinance them, and they have to do it at today’s rates.
When the cap rate on a property sits around 5% or 6%, borrowing at 2% creates positive leverage; the debt costs less than the property earns. Borrowing at 7% or 8% flips that relationship. The property now earns less than the debt costs, and every dollar of leverage works against the owner instead of for them.
Why Selling Does Not Solve It
The obvious response is to sell. The trouble is that buyers are pricing in today’s financing costs too. For a buyer to make the numbers work at current rates, the purchase price has to come down, sometimes significantly.
If the property is heavily leveraged, that price cut eats directly into the owner’s equity. An owner who put 20% down and is now facing a meaningful drop in value may find there is very little left after the loan is repaid, or nothing at all.
Four-to-One Leverage Was a Low-Rate Habit
For years, it was common to hear that you could get into real estate by borrowing four dollars for every one you put in. That approach made sense only because money was nearly free. It was a product of the zero-rate era, not a timeless rule.
If you own leveraged commercial property today, the question I would ask is whether you have the liquidity to respond if your financing turns against you. That means enough cash either to exit the property on your terms or to pay down a chunk of the debt so the deal no longer runs negative. Without that cushion, you can be forced into decisions on someone else’s timeline.
New Deals May Be the Safer Ones
Here is an interesting twist. Properties being developed and financed today may actually carry less risk than ones bought five or eight years ago. They are being underwritten at current rates, so the numbers already reflect today’s cost of capital, assuming rates do not climb much further.
From the projects and pitches clients have brought to us recently, it also looks like developers are using less debt than they were a few years ago. That is the market adjusting the way you would hope it would. Lower leverage and realistic rate assumptions make a deal more durable, even if the projected returns look less exciting on paper.
Cash Is an Opportunity in a Disruption
Every refinancing squeeze has another side. When owners need liquidity and lenders are cautious, investors holding cash have leverage of their own. During the 2008 financial crisis, Warren Buffett famously negotiated deals with major banks for preferred stock paying rich fixed dividends, because those banks needed capital and he had it.
You do not need to be Berkshire Hathaway to take a lesson from that. If you are sitting on meaningful cash, the next year or two may produce opportunities to buy quality real estate, or provide capital on favorable terms, from owners who have to act. I would want to know who is holding those Starbucks today, and who is holding them a year from now.
Whether you are the owner facing a refinance or the investor with dry powder, the time to plan is before the loan comes due, not after. That is a good conversation to start now with us, your advisors.
This post is adapted from a recent episode of the Scholar Wealth Podcast. For more perspective on what higher rates mean for leveraged commercial property, watch the full podcast episode here.