Bob Dylan… “The Times are A-Changin’”. I am not pretentious enough to say that I appreciate him as much as others. Though it was impressive that he chose to skip the Nobel Prize due to having “other plans”.
He was/is right though. It amazes me how long it can take things to change, but when they do, it happens over night.
Case and point, since the election, rates are up over 50 bps on most commercial loans. There was no slow progression toward this, it happened over 4 days. If you were in the unfortunate position of having an active loan, not rate locked, you paid a price. The prospect of lower corporate taxes is very appealing to the stock market. This leaves more capital for companies to invest in growth of all sorts. Hence, a mass sell-off of treasuries to re-invest in stocks, and an upward bump to bond yields.
Borrowers become comfortable with the status quo. “I don’t believe that rates will change,” and “The government can’t afford to raise rates”. In this case, it wasn’t the government that did anything directly. A few weeks later, the Federal Reserve raised the short-term rate by 25 bps. This impacts floaters, credit card debt, and corporate lines of credit more than anything else. Not mortgage rates directly.
For real estate investors, yes, higher interest rates usually result in higher capitalization rates. So, you immediately assume that values should drop. HOWEVER, lower corporate and personal tax rates should positively impact rental demand and the amount of space that tenants chose to occupy, which should drive NOI up. There will be more money available for real estate needs. Also, having more money available to invest in real estate, certainly wont hurt.
OPPORTUNITIES – WITH UPWARD RATES
Allow me to set the table first. The lending market has become completely inefficient.
On the bank side, there is a lot of experimenting going on right now. We have terms for the same loan from different lenders that vary by over 100 bps for nearly identical terms.
The CMBS world claims to be back in action, yet their reliance on the 5-year and 10-year swap or treasury, or whichever is higher, is making them less competitive with every basis point increase. They have priced in the new risk retention, maybe too high, so spreads are high, dollars are low, and they cant seem to really differentiate themselves in any positive way. That will change, I can promise that.
Life Companies… same as above. Of course if you have a 30% LTV loan request, you will get a lot of attention and some outstanding terms with flexibility. I haven’t met that borrower yet though. If you are that person, please call me!
Agency spreads have not adjusted with the increase in treasuries. So, their rates aren’t so good today.
Table set. Here is what we see:
Opportunity #1 – if you have CMBS, Life Co debt, FNMA, or Freddie debt, your prepayment penalty has just dropped materially. It is time to re-run the numbers, and weigh the costs and benefits of waiting to refi. Yes, you will pay a larger prepayment penalty now, but you may end up with a lower long term rate.
Opportunity #2 – Compare the different lending sources against each-other. We are seeing more banks doing non-recourse loans, at the right leverage level, with almost no prepayment penalties. Compare this option to a securitized loan, which may be longer term, but may also be locking you out against opportunities that may come to sell or refi.
Opportunity #3 – We are seeing property sales fall apart due to the change in the cost of debt. Hurdle rates of return are not being met with the higher interest rates, so buyers are trying to re-negotiate.
We see sellers acting somewhat “appalled” by this, noting that they are playing both sides, as they try to re-negotiate terms on where their 1031 investment is going toward.
That property that you were out-bid on, may be coming back to market. We are now working on two requests (in the past week) that our clients were out-bid on, and now seem to have new life.
If you are working toward a closing right now… my advice is to rate lock ASAP. If you have not rate locked, we should show you some other options before you sign the dotted line. You will likely be pleasantly surprised.
If you have a CMBS, FNMA or Freddie loan with less than 2 years of term left, strongly consider refinancing now, paying the penalty, and locking in a solid long term rate while rates are still low.
If you are on a LIBOR floater, look to refi to a fixed rate, or purchase a cap, or do a rate swap.
If you are currently shopping debt or looking to purchase a property, patience will not be a virtue in the short run, it will be a detriment.
Be open minded. Your debt strategy will potentially set you apart from the pack of buyers right now. If you like multifamily, run the numbers with bank debt at lower leverage (to keep in as non-recourse). Factor in that there is minimal to no prepayment penalty. While every buyer is adding 100 bps in debt to their IRR formula, you may be able to leave it the same.
So, there you have it. While the “Times Are A-Changin” , the guarantee is that they will change again, and this blog will require updating. So, the song will far outlive where things are in finance today.