The recent sell-off in global bond markets pushed sovereign yields to multi-year, or even multi-decade, highs as investors demanded more compensation for multiple elevated risks. These include raised inflation, large government deficits, geopolitical uncertainty and heavy borrowing tied to AI infrastructure.
For commercial real estate, this is a major headwind. Higher risk-free yields make bonds more competitive with property income, so investors demand higher cap rates. That typically forces valuations lower. It also raises debt costs, reduces leveraged buyers’ purchasing power, and slows transactions and liquidity.
Then there is capital competition. “What makes the current environment unusual is that several forces are pushing in the same direction,” says Jani Nokkanen, CIO at Urban Partners. “Alongside inflation and fiscal concerns, we are seeing extraordinary amounts of capital being absorbed by AI and data centre investment. That creates greater competition for capital across markets.”
Higher government bond yields raise the risk-free rate, narrowing the spread that real estate has over bonds. They mean higher debt and hedging costs, which reduce levered returns, so buyers must pay less to hit the same target return. Uma Moriarity, senior investment strategist at CenterSquare, says: “Underwriting should assume no cap rate compression at exit. With the 10-year above 5%, positive leverage has largely disappeared.” It typically takes a few quarters for this to pass through to private market valuations, but listed real estate reprices in real-time, and in the US their fall implies about a 7% hit to underlying asset values.
Of course, the real impact of any revaluation depends on what an asset owner’s financing position is, and whether they can see through this environment, or need to refinance. “A loan with an all-in cost of 2.5% against a 2020 valuation does not refinance cleanly at 6% against today’s value,” says David King, senior managing director and co-head of European real estate at Harbert Management Corporation. “The borrower faces some combination of injecting fresh equity, accepting tighter terms, or selling.”
Many floating-rate loans originated when low government bond yields meant benchmark rates were near zero. “Higher rates raise debt service while lower values shrink what a new lender will advance, leaving a gap that must be filled,” says Kyle Jeffers, CIO of Acore Capital. And the volume is large: $2.6trn (€2.32trn) of US commercial real estate loans mature between 2026 and 2029, with $875bn maturing this year, according to the MBA.
Delinquency is a two-tier experience across all sectors. Jeremy Hodgson, partner at Allsop, comments: “While prime assets have remained relatively stable, investors in higher-yielding secondary stock tend to rely more heavily on debt. Sectors with higher vacancy rates tend to be most exposed.”
Some sectors are clearly more sensitive to rate movements than others. “Rate rises are designed to cool demand, so the sectors most exposed to economic activity feel it first: offices and retail, and to a lesser extent the more cyclical segments of industrial and logistics, where occupier demand tracks GDP,” says King. “Sectors with counter-cyclical or non-discretionary demand hold up better. Student accommodation enrolment has historically risen in downturns, and mid-market rental housing is underpinned by a structural shortage: new household formation across major European markets continues to run well ahead of completions,” he adds.
Clearly, there are broader structural themes to consider. According to Nokkanen, rates are only part of the picture. “Offices and retail face additional structural pressures, while residential and logistics continue to benefit from stronger supply-demand dynamics,” he says.
Either way, offices look exposed. “Today, office still carries the largest stock of legacy distress,” notes Cameron LaPoint, assistant professor at Yale School of Management. Trepp’s September 2026 CMBS data show office delinquencies at 12.16%, compared with 8.04% for multifamily, 6.58% for retail and just 1.14% for industrial.
Survival strategies
While the delinquency rate certainly appears alarming in a historical context, investors need to take a balanced view, according to Moriarity. “The pass-through of rate increases to cap rates isn’t one-for-one, in part because of the inflation protection afforded by real estate that you wouldn’t get from fixed income,” he states. “The same buffering effect applies…as the perceived level of risk in government debt increases, the required spread between real estate and government debt naturally shrinks, meaning cap rates do not need to rise as drastically as borrowing costs do.” And government bonds certainly seem risky right now.
Inflation protection is the life raft. For Keith Breslauer, CEO of Patron Capital, the question is “whether rental growth, particularly where rents are inflation-linked, is sufficient to offset the reduction in value caused by higher rates. Multifamily, for example, can benefit from inflation-linked rents, while assets such as self-storage have much shorter rental periods and can therefore reprice more quickly”.
That quest for income has implications. As Crispin Gandy, CEO of Argo Real Estate, says: “It is almost impossible to achieve superior returns through passive strategies in a higher interest rate environment. With higher borrowing costs, leverage is less accretive, so returns must be driven through active asset management, principally by growing income.”
This means recalibrating investment strategies. “When rates are higher, the bar is raised for every allocation,” says Moriarity. “Investors seeking real estate exposure consequently move up the risk spectrum to core-plus or value-add, instead of parking in core real estate with limited return potential. When investors can get a 5%-plus return by investing in ‘risk-free’ US Treasuries, why would you take any risk at all to get ‘core’ returns of 6-7%?”
Jacob Slone, MD at Harbor Group International, agrees. “As the cost of capital increases, investors’ return expectations increase commensurately. These higher returns can often be found in value-add and distressed assets.”
But Jeff Bingham, chief macro and investment strategist at Heitman, is more cautious. “Rising rates do not automatically push investors from core assets toward value-add or distressed opportunities. An investor’s risk aversion is the primary driver behind allocation across the risk spectrum,” he says.
More clear-cut in his view is the effect on development. “When construction debt becomes more expensive, development pipelines typically shrink and project starts decline. The immediate effect is less construction,” he says. This is exacerbated when other factors are present, Jeffers points out: “Rates are not the only cause: elevated construction costs, labour shortages and oversupply in some markets have also weighed on starts.”
There is one exception, and a clear survival strength: data centres. “The near-term pipeline is unusually insulated because much of the demand is already committed, power is scarce, and hyperscalers can draw on very large balance sheets and infrastructure capital pools,” says LaPoint. However, he qualifies: “The bigger risk emerges if higher rates persist long enough to challenge the economics of the AI buildout itself.”
The way out?
It’s important not to be too gloomy on distress. Breslauer says doing so “assumes borrowers are highly leveraged and banks are forced to sell assets. That is obviously not the case today.
“Banks are generally healthier, leverage is lower and there is more room within capital structures, so we are unlikely to see the same wave of non-performing loans and forced sales that followed the global financial crisis.”
There is another way out, highlighted by Bingham. “The good news is that economic growth is currently stable or accelerating,” he says. Growth could bail out government debt issues and boost demand, though this is more likely in the US than Europe. Nominal GDP quarter-on-quarter growth is running at 8.5% there, compared to just 0.8% in the UK. In Europe, in real terms it is just 0.6%. If that continues, it may provide the ‘demand’ for supply/demand to come back into balance.
And raised bond yields are certainly shrinking the supply side. Says Moriarity: “This is central to the thinking I have around real estate right now. This will be a net benefit for real estate fundamentals in the coming years.”
The pressure from higher bond yields and rising interest rates on real estate coincides more intense competition from other investment areas – most notably AI and data centres.
“Capital is undeniably being pulled towards infrastructure, whether for AI or the energy transition, and real estate competes for the same institutional allocations,” says King.
The sheer scale of the AI effect must be acknowledged. Data centre debt issuance has risen from about $150bn in 2022 to roughly $500bn year to date, and AI-related issuances now represent about 31% of net US Treasury issuances versus only 6% in 2022. Moriarity observes: “The sheer supply of debt at that tenor is impacting pricing across the board.”
Climate transition adds another claim on that capital, according to LaPoint. “For many assets it is becoming defensive capital expenditure to preserve occupier demand as well as the asset’s marketability and liquidity. The consequence is likely to be less a general shortage of capital than a much sharper rationing of it. Assets combining weak growth, refinancing requirements and substantial retrofit needs will find the hurdle considerably higher.”
