Interest Paid vs. Interest Impacted

What is Interest Impacted?

Interest Impacted (often referred to as Interest Rate Impact) is a broader financial concept. It describes how changes in the prevailing interest rate environment "impact" the overall performance, valuation, and risk profile of a commercial property, regardless of whether the loan rate itself has changed.

The ways a property is Interest Impacted include:

• Valuation and Cap Rates: There is a historical correlation between interest rates and capitalization (cap) rates. When market interest rates rise, investors typically demand higher yields, which can lead to an expansion of cap rates and a subsequent decrease in property value.
• Debt Service Coverage Ratio (DSCR): A property is "impacted" when rising rates make new debt more expensive. If a borrower needs to refinance, a higher interest rate will increase the debt service requirements, potentially lowering the DSCR to a level where the lender will not approve the loan.
• Exit Strategy Risk: If a borrower intends to sell a property in a high-interest-rate environment, the pool of potential buyers may shrink because their cost of acquisition financing has increased, thereby impacting the seller's final proceeds.
• Opportunity Cost: Interest rates impact the "hurdle rate" for investors. If risk-free rates (like Treasury bonds) rise, the relative attractiveness of a commercial mortgage or real estate investment may be impacted, forcing a shift in capital allocation.

The Strategic Difference

The primary difference between the two lies in quantification versus qualification. Interest Paid is a quantifiable figure found on a monthly bank statement; it represents the cost of debt. Conversely, Interest Impacted is a qualitative and quantitative measure of market risk.

An investor might have a fixed-rate mortgage where the Interest Paid remains exactly the same for ten years. However, if market rates double during that time, the property is still heavily Interest Impacted because its market value may have dropped and its future refinancing potential has become more difficult. Understanding both concepts allows commercial mortgage professionals to better hedge against risk and optimize the long-term returns of a real estate portfolio.