5 Keys to the Construction of the Interest Rate
Between shifting Fed purchases of Treasury securities and periodic changes in how much mortgage-backed security (MBS) purchasing the GSEs — Fannie Mae and Freddie Mac — take on, interest rates can react in both directions over any given stretch.
Understanding how the interest rate is influenced can help investors make smarter decisions about where and how to manage their property loans.
1. Why the 10-Year Treasury Matters So Much
If you invest in real estate long enough, you’ll hear this phrase repeatedly: “Watch the 10-year.”
The 10-year U.S. Treasury yield is the single most important benchmark influencing borrowing costs across the real estate market. Whether you’re financing a multifamily deal, refinancing an office building, or underwriting a long-term hold, movements in the 10-year Treasury quietly shape interest rates, investor returns, and ultimately property values.
- The 10-year Treasury yield is a key benchmark for fixed-rate mortgages; when its yield rises, mortgage rates generally rise, and when it falls, mortgage rates tend to fall, because lenders price mortgages by adding a spread (covering costs, profits, and risk) to the 10-year Treasury rate, making it a strong indicator for long-term borrowing costs.
- This relationship holds because investors buying mortgage-backed securities (MBS) need to earn a competitive return compared to the relatively safe 10-year Treasury, so higher Treasury yields push mortgage rates up to attract investment.
- At its core, the 10-year Treasury yield represents the market’s view of long-term risk-free returns. Investors around the world use it as a baseline for pricing everything from mortgages to corporate bonds.
For real estate investors, the connection is straightforward: long-term fixed-rate real estate loans are priced as a spread over the 10-year Treasury.
Most permanent financing — especially agency, CMBS, life company, and long-term bank debt — moves directionally with the 10-year, even if not tick-for-tick.
The mortgage rate offered to borrowers is determined by adding a spread to the benchmark 10-year Treasury note.
- The mortgage spread can be broken into two major components: the primary-secondary spread, which represents industry origination costs such as servicing fees, guaranty fees, and other lender costs and profits.
- The secondary spread, which represents the additional risk that investors take on when investing in an MBS relative to investing in a 10-year Treasury.
A common investor mistake is assuming mortgage rates move directly with the Federal Reserve. They don’t — at least not in a clean, linear way.
2. Treasury Yields vs. the Fed Funds Rate
The Fed controls the overnight lending rate, not long-term yields. The overnight rate is what banks lend to each other on a daily basis. The 10-year Treasury is set by the bond market, based on expectations for:
- Inflation
- Economic growth
- Future Fed policy
- Global demand for U.S. debt
This is why mortgage rates can fall even while the Fed is holding rates steady, or remain elevated after the Fed begins cutting. The bond market is forward-looking; real estate investors should be too.
3. Residential Rates vs. Commercial — Why Are They Different?
Most residential loans are made under conforming loan guidelines provided by the GSEs, primarily Fannie Mae and Freddie Mac.
- These entities ensure consistent standards and provide guarantees as a result of these standards, which make them eligible to bundle and sell as a mortgage-backed security.
- The GSEs also provide loans for multifamily properties, with loans starting around $1.5 million, and better rates at the $3M threshold and larger. Very careful standards must be followed in order to meet the guidelines and receive the guarantees from the GSEs. Rates are frequently better than a 30-year residential rate for high-quality GSE multifamily loans because the borrowing costs and risk premium — “the spread” — is lower for these agency-backed multifamily loans.
Outside of those agencies, most commercial real estate is funded with alternate lending from banks, credit unions, and large life insurance companies. Most of this lending is kept in their own portfolios.
- Commercial bank mortgage rates are typically about 50 to 100 basis points (0.50% to 1.00%) higher than the prime, 30-year residential mortgage rate.
- Commercial mortgage rates on SBA loans and USDA loans are typically 2% to 2.5% higher than the prime residential mortgage rate.
There are commercial mortgage-backed securities (CMBS) which have very stringent standards to meet in order to be sold as a security.
- One of the most commonly misunderstood standards, from property owners’ viewpoint, is that a CMBS loan must not be modified in any way, and if paid off early, holds significant prepayment penalties in order to guarantee the yield.
- The commercial mortgage rates of life companies and conduits — because the loans are typically quite large ($3MM+) — are a little better than the commercial mortgage rates of the typical bank. You can expect to pay 35 to 75 basis points (0.35% to 0.75%) over the prime, 30-year residential mortgage rate.
4. The Role of the 5-Year Treasury: Increasingly Important
In recent years, investors have also had to pay closer attention to the 5-year Treasury, which plays a growing role in short-to-medium-term financing and transitional debt.
Conventional wisdom will have most people comparing mortgage rates to 10-year Treasuries, but in periods of elevated rate volatility, the 5-year Treasury can be a better benchmark, providing a more realistic idea of what is happening to spreads.
This is because the 5-year Treasury more accurately reflects volatility in the market over a shorter timeframe.
The 5-year Treasury heavily influences:
- Bridge loans
- Short-term bank financing
- Transitional debt
- Value-add and repositioning strategies
Many floating-rate loans are priced off SOFR, but lender hedging and fixed-period pricing often reference the 5-year Treasury. As a result, changes in the 5-year yield can directly impact rate caps, swap costs, and refinance assumptions.
During periods of heightened market volatility, investors should keep a close eye on the 5-year Treasury alongside the 10-year.
5. Strategic Moves Investors Should Make
If you are an investor with loans that will come due or float within the next two years, you should consider whether the coming year is the right time to refinance.
- When rates are trending lower, it can also be a good time to sell a property, since cap rates tend to compress as interest rates fall.
- When interest rates are expected to float lower over time, choosing a floating rate on short-term financing may be a smart move.
- Negotiate from a position of strength: in a shifting rate environment, the spread matters as much as the base rate. If you are financing a strong asset with strong value, negotiate for better terms, as lenders will be more aggressive for quality deals.
A well-negotiated loan at a tight spread over the Treasury can outperform a cheaper headline rate with restrictive terms.
Bottom Line
Real estate investors who carefully watch the bond market and understand the factors in play can make smart decisions and use the market in their favor. Timing on loans and the interest rate received can make the difference between a break-even investment and a superior cash-flowing asset.
Many investors we work with understand that making careful decisions to let the market work in their favor is one of the easiest ways to make money. If you are looking to sell or buy when the market is working with you, contact us to ensure you get the strong return you are planning on.
