Nominal vs. Effective Interest Rates

 April 4, 2022

By  Guy Gray

Interest rates in commercial real estate aren’t as simple as you might think. What’s the difference between nominal and effective interest rates, for example? Is one better suited for CRE than the other? Why should you even care?

Once found only deep within the realm of financial news sections, these interest rates are becoming more relevant. Let’s give them a little more attention.

Interest Rates in Commercial Real Estate

There are a wide variety of interest rates that CRE professionals have to deal with on a daily basis. Nominal and effective interest rates are just two of them. Other types you can encounter include compounding interest rates, rates based on time period and more (which can also be sub-types of nominal and effective rates, by the way). Interest rates are often called “rate of yield” or “rate of return” in the CRE industry. Quoting, giving and analyzing interest rates are all part of the territory when it comes to predicting returns.

Nominal vs. Effective Interest Rates, Defined

Now let’s dive a little deeper into what each of these rates mean. For starters, “nominal interest rate” refers to the total amount of interest paid in a given period, with no consideration for how many times it’s compounded. “Effective interest rate,” on the other hand, does take into account the compounding factor. Compounding, or interest on interest (if you will), dictates the actual interest rate increases over time. So while effective interest rates are more accurate in predicting actual interest amounts, nominal interest rates focus on the number of times interest rates compound instead.

Why These Rates Matter (and How To Manage Them)

Nominal and effective interest rates are crucial when it comes to predicting rates of return, planning for the future and making any changes to leases (and lease negotiations) moving forward. Crunching the numbers for these rates can be extremely complex and require math skills, however, so we recommend using commercial real estate software like Quarem to automate some of the data processing and purge your results of inevitable human error. This allows you to focus on the bigger picture of your leases and quickly access the yield return data you need for making decisions.

If you’re interested in seeing how commercial real estate software can help you track and manage interest rates and other CRE metrics, request a demo of Quarem today.

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About the author 

Guy Gray

Guy Gray serves as Chief Operating Officer overseeing our technology and client services teams. He is responsible for guiding Quarem application development, networking and security, as well as new client implementations.

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