Interest rates determine how expensive it is to hold, refinance, and transfer ownership of a property over time. Real estate is often a long-duration asset, with cash flows stretching years into the future. Transactions are infrequent, and financing is typically layered on top of the asset for long periods. Changes in interest rates can affect real estate in three primary areas: debt service, valuation, and liquidity. Each operates on a different timeline, and none require the property itself to deteriorate for pressure to build.
Impact on Debt Service
The most immediate effect of interest rates is on the cost of debt.
For fixed-rate loans, the rate is locked in at origination, but the rate environment still matters. Higher rates reduce loan proceeds, increase required coverage, and limit refinancing options at maturity. The impact may not be felt on day one, but it becomes unavoidable when a loan needs to be replaced.
For floating-rate loans, the connection is direct. As benchmark rates rise, required payments increase even if rents and occupancy remain unchanged. For example, consider a property with a $1,000,000 loan amortized over 30 years. At a 5.0 percent interest rate, annual debt service is roughly $64,000. At 6.5 percent, that figure rises to about $76,000. At 7.5 percent, it approaches $84,000. The property’s NOI does not change, but a larger share of it is redirected toward debt service as rates rise, compressing or eliminating cash flow.
Interest-only periods amplify this effect. When principal is not being reduced, the loan balance remains high. If rates are higher at maturity, the same NOI supports less debt, increasing the likelihood that equity must be contributed to refinance.
Higher interest rates do not break properties immediately. They reduce the amount of variation the financing can absorb before cash flow tightens or capital is required.
Impact on Valuation
Interest rates also affect how real estate is valued.
One way to think about this is to consider what an interest rate represents. At its most basic level, an interest rate reflects the return an investor can earn by lending cash. U.S. Treasury bonds, often treated as a risk-free benchmark, set a reference point for that return. If an investor can earn a comparable return by holding Treasuries, without taking on property-level risk, operational complexity, or illiquidity, demand for real estate weakens. That shift places downward pressure on property values.
Income-producing real estate is typically valued by capitalizing net operating income. As interest rates rise, required returns tend to rise as well. Cap rates do not move one-for-one with interest rates, but higher rates generally translate into lower valuations over time.
This effect matters most when a property is refinanced or sold. A relatively modest increase in cap rates can materially reduce value even if NOI is unchanged. For leveraged properties, that reduction shows up directly as lower refinance proceeds or diminished equity at sale.
Impact on Liquidity
Rising interest rates also affect liquidity.
As borrowing costs increase, fewer buyers can meet return thresholds. Sellers anchored to prior pricing may delay transactions. Bid-ask spreads widen. Transaction volume slows.
This does not mean properties stop operating. It means exits become harder to execute on favorable terms. Investors relying on sale or refinance within a specific window are more exposed to rate-driven slowdowns than investors focused on long-term cash flow.
In periods of rising rates, real estate becomes less liquid at the same time financing becomes more restrictive.
Consider an individual investor who purchased a small multifamily property in 2021 for $1.2 million. The acquisition was financed with a 75 percent loan-to-value mortgage, resulting in an original loan balance of $900,000 at a low fixed interest rate. At the time of purchase, cap rates were compressed, borrowing costs were low, and comparable sales supported the valuation.
The property performs as expected. Rents have held, operating expenses are manageable, and current net operating income comfortably covers debt service. From a cash flow perspective, the deal still works. There is no distress and no immediate pressure from the lender.
By 2025, interest rates are materially higher. Cap rates in the market have moved up as buyers underwrite to higher return requirements. Comparable properties are now trading closer to a 7.5 percent cap rate rather than the 5.5 percent cap rate prevalent at the time of purchase.
At the higher cap rate, the property’s value is now closer to $950,000 to $1.0 million, despite NOI being largely unchanged. Selling at that level would not generate sufficient proceeds to retire the existing loan after transaction costs. Refinancing produces a similar outcome, as higher rates and tighter underwriting reduce available loan proceeds.
The investor continues to own the property. Cash flow supports the debt service, and the lender is being paid on time. However, an exit is no longer available without contributing additional equity.
This is how rising interest rates affect liquidity in real estate. Assets do not stop functioning, but fewer buyers can justify prior pricing, and financing no longer bridges the gap. Transactions slow, bid-ask spreads widen, and investors who need to exit on a specific timeline find that the market no longer accommodates them.
Conclusion
Interest rates do not change the physical asset. They change how expensive it is to carry, refinance, and exit that asset.
At lower rates, mistakes are easier to survive. At higher rates, the same structure has less room. Properties do not need to fail for interest rates to matter. The obligations attached to them feel the change first.
That is how interest rates work their way through real estate.