Chicago, Illinois, February 1, 2018 – Benchmark rates hit a three-year high this week, as investors track Fed monetary moves in the face of new government spending needs and worldwide economic growth. Following this trendline, mortgage rates are on the rise, although not at full parity. Property owners can expect to see the following underwriting trends over the coming months:
Active Rate Management: Low rates are no longer taken for granted, and simply capturing cheap debt is becoming more difficult. With short and long-term rates rising, hedging and other interest-rate protection strategies are resurfacing. Moreover, creative lenders offer options such as float-to-fix loans (or vice versa) for greater optionality, if borrowers feel compelled to lock into fixed rates due to increased pricing concerns, or alternatively need to reorganize loans to avoid incurring prepayment penalties associated with fixed-rate debt (usually necessary, if an asset sale is planned in the near future).
Tighter Spreads: The trade-off of lower rates for lower leverage benefits borrowers targeting the best pricing. Even as benchmark rates climbed over thirty basis points within the month, lenders absorbed spreads to keep loan production fluid. Mortgage rates are only five to fifteen basis points higher, as a net result.
Debt Service Coverage: Lower leverage loans are the norm in comparison to historical levels. As prices rise for premier properties, borrowers are forced to accept less proceeds since debt service coverage supersedes loan-to-value limits as a key underwriting variable in these cases. High prices directly translate to higher equity contributions, in exchange for favorable debt terms. For best pricing, 65% LTV or less are commonplace, often based upon 1.40X or more debt service coverage.
Mr. John Oharenko, director of the Real Estate Capital Institute® , advises, “Borrowers are definitely paying attention to higher rates, after enjoying extremely low rates for a several years. As rates gradually rise, sellers and buyers will realign their expectations, but at a slower, wait-and-see pace.”