Interest Rate
Impact

Fed Funds vs. 10-year Treasury

Mortgage rates track the 10-year Treasury more closely than the Fed Funds Rate. Spread typically 150–250 bps. Fed Funds sets short-term; Treasury reflects long-term inflation and growth expectations. During tightening cycles, yield curve can invert (Fed Funds > 10yr), signaling recession but not necessarily driving mortgage rates higher proportionally.

Cap rate spread over Treasury

Historic spread: Cap rate over 10-year Treasury
  Multifamily:         150-300 bps
  Industrial:          200-350 bps
  Retail:              250-400 bps
  Office:              300-500 bps (wider in risk-off markets)

Example 2021 vs 2024:
  2021: 10yr = 1.5%, Multifamily cap = 4.0% (250 bps spread)
  2024: 10yr = 4.2%, Multifamily cap = 5.5% (130 bps spread)

In 2024, spread has COMPRESSED relative to historical norm.
Suggests further cap rate expansion likely or T-rate decline
needed to restore equilibrium.

Cap rate compression and expansion

Cap rate = NOI / Value. When rates rise:

• Debt service rises, reducing cash-on-cash return at same LTV
• Required risk premium rises — buyers demand higher cap rate
• Cap rate expands, Value falls (at constant NOI)
• 25-100 bps cap rate expansion = 5-20% value decline

A 5% cap rate asset loses 20% of value if cap expands to 6.25%. 2022–2024 most CRE sectors expanded 50–200 bps, resulting in 10–30% value declines.

IRR decomposition

IRR components on leveraged real estate:
  Current cashflow yield        +    4-8% unlevered
  Rent growth (appreciation)    +    2-4%
  Principal paydown (leverage)  +    1-3%
  Cap rate compression          +    0-3%
  Tax benefits (depreciation)   +    1-3%
  = Total IRR                        10-20%

Rising rates compress:
  Cashflow yield (higher debt service)
  Cap rate compression (reverse to expansion)
  Exit value (cap rate expansion reduces value)

Unlevered real estate can still produce real returns in
rate-rising environment. Leveraged returns suffer more.

Leverage as amplifier

Leverage amplifies returns both up and down. At 75% LTV:

• 10% asset appreciation = 40% equity IRR (before debt service)
• 10% asset decline = 40% equity IRR loss
• Cap rate expansion 100 bps wipes out 2–3 years of cashflow

In rate-up environment, conservative 50–60% LTV materially reduces downside vs. 75–80% aggressive.

Historical Fed cycles

• 1994 Greenspan — 300 bps in 12 months
• 2004–2006 — 425 bps from 1% to 5.25% in 2 years
• 2015–2019 — 225 bps from 0.25% to 2.5% over 4 years
• 2022–2023 — 525 bps from 0% to 5.25–5.5% in 16 months (fastest since Volcker)
• 2024–2026 — cuts projected 100–200 bps toward 3.5–4.25%

Bridge loan exposure

Floating-rate bridge loans exposed directly to SOFR/Prime. A SOFR + 500 bps bridge went from 4.5% in Q1 2022 to 10.0% by Q3 2023 — same loan, 2.2x monthly interest cost. Debt service ballooned. Properties that penciled at 4.5% couldn’t support 10%+ debt service. 2023–2025 saw bridge default wave. Rate cap purchases ($100k–500k on $10M loan) partially mitigated but couldn’t prevent all distress.

Assumable mortgage arbitrage

2020–2021 FHA/VA mortgages at 2.5–3.5% rates became premium assets. Buyers paid 5–15% premium for assumable listings. Rate spread created real value: $300k mortgage at 3% vs 7% saves $800+/month for 27 remaining years = $260k+ NPV advantage. Sellers and listing agents who understand and market the assumption capture this value. See creative-debt reference.

Rate stress testing

Every underwriting should stress test:

• Current rate + 100 bps at exit refi
• Current rate + 200 bps at exit refi
• Floating rate + 300 bps (on bridge)
• Take-out financing at current spread (not historical)
• Interest rate cap cost at projected levels

Deal should survive +200 bps scenario with at least breakeven cashflow. If it doesn’t, leverage is too high.

Common pitfalls

• Underwriting to historical rates. Projecting 4% rate refi in 2026 when current is 7%. Rate expectations built into projections don’t materialize.
• Floating rate without cap. Bridge loan without rate cap. SOFR jumps. Debt service doubles. Negative cashflow.
• Bridge maturing into tight market. 2024 saw $500B+ bridge maturities with constrained refi market. Extension fees, forced sales.
• Concentration in rate-sensitive strategy. Flipping during hike cycle. Holding costs rise faster than buyer capacity.
• Prepay penalty trap at rate drop. Refinancing 2021 3% to 2.5% in 2020 paid massive YM. Similarly 2024 7% to 2026 5% will face lesser YM. Budget penalty.
• Short-term assumption on exit rate. 5-year hold, assume exit at today’s rate. Rate could be 200 bps higher at exit.
• Ignoring cap rate - rate correlation. Assumes cap rate holds during hike cycle. Cap rate expands 50–100 bps per 100 bps rate rise typically.
• Missing assumption opportunity. Low-rate assumable mortgage on listing, ignored by buyer/agent. Free 10–15% premium left on table.