The Impact of Lower Federal Reserve Interest Rates on Capital Gains and Borrowing in 2024

Jan 22, 2024

A potential Federal Reserve interest rate cut in 2024 can have specific implications for buyers involved in Triple Net Lease (NNN) transactions. NNN leases are a type of commercial real estate lease where tenants bear the responsibility for property expenses, including property taxes, insurance, and maintenance costs, in addition to rent.

Here’s how a potential 2024 Fed interest rate cut may affect NNN lease buyers.

Potential Benefits to NNN Lease Buyers

Each time the federal reserve announces interest rate increases or decreases, the economic marketplace experiences widespread ramifications.

The high availability of cash in the market due to COVID 19 has impacted inflation, investment activity, employment, and the job market. After consistently raising interest rates since March 2022, Federal Reserve chair, Jerome Powell, has announced the Fed will pause rate hikes at key levels in 2024. Market indicators suggest that these rate hike pauses may lead to a drop in interest rates in the first half of 2024.

Increased Access to Capital: A drop in interest rates could indicate that the Federal government is interested in stimulating investment opportunities, making money more accessible and easier to borrow. Lower interest rates can translate into more affordable financing for NNN lease buyers. If buyers are financing their property acquisition, a rate cut could lead to lower mortgage rates, reducing the overall cost of financing. This can enhance the buyer’s return on investment and improve the property’s cash flow.

Impact on Cap Rates: Capitalization rates (cap rates) are a key metric in commercial real estate, calculated by dividing the property’s net operating income (NOI) by its current market value. Although cap rates can be affected by interest rates the biggest driver is supply vs. demand.

Stimulated Investment Activity: Lower interest rates can stimulate overall investment activity in the commercial real estate market. As financing becomes more accessible and affordable, NNN lease buyers may find increased competition, and property values may increase in response. This dynamic market can benefit sellers but may present challenges for buyers seeking attractively priced properties.

graphic of building blocks showing rise and fall of percentage interest rates

Considerations and Potential Challenges to a Fed Interest Rate Decrease

Rising Property Prices: While lower interest rates can make financing more affordable, lower rates may also contribute to rising property prices. NNN lease buyers should carefully evaluate whether the potential increase in property values aligns with their investment goals and expected returns. As mentioned above the biggest drive in cap rates is supply vs demand.

Increased Competition for NNN Properties: A lower interest rate environment often leads to increased competition among investors for desirable NNN properties. Buyers may encounter more competition, potentially making it challenging to secure properties at favorable prices. Thorough market research and a well-defined investment strategy become crucial in such scenarios.

Potential for Increased Yield Compression: Yield compression occurs when capitalization rates decrease, leading to lower yields for investors. While this can result in property value appreciation, it also means that the income return on the investment may be lower. NNN lease buyers should carefully assess whether the expected rental income justifies the investment.

Economic Indicators and Tenant Stability: NNN lease buyers should closely monitor economic indicators and tenant stability. While lower interest rates can stimulate economic growth, uncertainties or economic challenges in specific sectors may impact tenant performance and, consequently, the stability of rental income.

Strategic Considerations for NNN Lease Buyers

Thorough Due Diligence: Conduct thorough due diligence on your potential NNN properties. Evaluate the financial health of tenants, lease terms, and the property’s overall condition. This diligence becomes even more critical in a competitive market.

Evaluate Financing Options: With potentially lower interest rates, NNN lease buyers should explore different financing options to secure the most favorable terms. Engage with lenders to understand the impact of interest rate changes on loan terms and conditions.

Diversify Your Portfolio: Consider diversifying your NNN lease portfolio to mitigate risk. A well-diversified portfolio can provide stability, even if certain sectors or tenants face challenges.

Think Long-Term: Assess your NNN investments in 2024 with a long-term perspective. While short-term market dynamics and interest rate changes can impact property values, a well-located and well-leased NNN property can provide stable returns over the long term.

graphic showing fluctuating interest rates and value of American currency

The costs and benefits to a Federal Reserve interest rate cut in 2024

A potential Federal Reserve interest rate cut in 2024 presents both opportunities and challenges for NNN lease buyers. While lower interest rates might reduce financing costs and enhance property values, increased competition and potential yield compression require strategic planning and careful consideration of market dynamics. Thorough due diligence, evaluation of financing options, and a long-term investment perspective are essential for NNN lease buyers navigating the evolving commercial real estate landscape.

Buyers with the capital reserves on hand may choose to buy now while cap rates are higher and before the Fed lowers rates. Once the Fed lowers interest rates, buyers will jump back into the market and cap rates will start to compress again.

Have the capital to invest before the market gets crowded again, but not sure how to begin your NNN lease buying journey? Our no-obligation consultations are free. Contact our advisors today: 314-997-5227

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