Higher rates and tougher deals: Commercial real estate under pressure - by William Pastuszek

The recent increase in government-backed benchmark rates, particularly U.S. Treasury yields, is working its way into lending rates. The 10-year Treasury rose from 4.18% at year-end 2025 to 5.21% on October 13, 2026, an increase of 103 basis points. Because many fixed-rate commercial mortgages are priced at a spread over Treasury yields, a higher benchmark generally produces a higher loan coupon unless lender spreads compress enough to offset the increase. Lender sources report a rush to close transactions before existing term sheets expire and anticipate a slowdown in financing activity.

Residential mortgage rates provide an interesting, although imperfect, parallel. Freddie Mac reported that the average 30-year fixed-rate mortgage reached 7.4% on October 8, up from 5.98% on February 26 and 6.3% one year earlier. Residential mortgages differ from commercial loans in term, amortization, prepayment structure, underwriting, and government support. Nevertheless, the direction is instructive: when the long end of the yield curve rises, borrowing costs ultimately rise for property owners.

The market response usually involves a lag. As higher rates become embedded in lender quotations and borrower expectations, refinancing activity is likely to slow. The effect on sales activity remains uncertain because property inventories are still relatively tight in many local markets. Limited supply may support pricing, but reduced debt proceeds and higher equity requirements can narrow the pool of qualified buyers.

The relationship between interest rates and capitalization rates is real, but it is not mechanical. A capitalization rate expresses the relationship between a property’s net operating income and its price or value. It reflects the market’s required unleveraged return for property-specific and market risks. Debt rates, by contrast, are more directly influenced by lenders’ cost of funds, benchmark rates, credit spreads, and underwriting requirements.

Treasury securities offer investors a comparatively low-risk alternative. Real estate investors therefore require compensation for illiquidity, operating risk, capital requirements, leasing uncertainty, and other ownership exposures. Rising Treasury yields can place upward pressure on capitalization rates and downward pressure on property values. A 50 bp change, say from 5 – 5.5%, holding all else equal, results in a substantial value difference. 

Capitalization rates, however, do not move point-for-point with interest rates. CBRE’s U.S. Cap Rate Survey for the first half of 2026 found that its all-property average capitalization rate was essentially unchanged even though the 10-year Treasury yield had risen substantially. Property fundamentals, expected rent growth, available capital, investor risk tolerance, asset quality, inventory, and location can either absorb or magnify the effect. Apartments with durable occupancy and credible rent growth in a strong market such as metropolitan Boston may resist capitalization-rate expansion better than properties facing weak demand, deferred maintenance, or substantial capital needs.

Higher rates also affect leveraged cash flow directly. For acquisitions and refinancings, greater debt service reduces cash flow after debt service and lowers cash-on-cash returns. Higher borrowing costs may also reduce loan proceeds because lenders must satisfy debt-service-coverage and loan-to-value requirements. Owners confronting loan maturities may have to contribute additional equity, accept smaller proceeds, or sell. Some troubled assets may become more distressed, particularly properties already affected by the first post-pandemic round of rate increases.

Owner-occupied properties may be somewhat less sensitive when investor-oriented cash-flow returns are not the primary motivation. Even so, higher rates can reduce transaction volume and skew market indicators. Credible comparable market evidence may be more difficult to obtain.

Conclusion. Higher rates, persistent inflation, and the possibility of further increases are now facts of the real estate market. Cap rates do not move in lockstep with financing costs, and their response may not appear immediately in transaction data. That delay makes careful underwriting, current market support, and heightened valuation vigilance essential.

William Pastuszek, Jr. MAI, ASA, MRA heads Shepherd Associates LLC, Needham, Mass.