Thinking of Interest Rate Risk

by John Wilhoit Jr. on

With respect to long-term ownership of income property, the capital stack (including debt) should reflect ownership’s objectives on preservation of capital, yield on invested capital and capital gains.  Interest rate strategy is  part  of strategic planning in multifamily financing.   Long-term mortgage financing should  provide consideration for the entire term of ownership; from date of acquisition t0 disposition. 

Since the Federal Reserve announced Quantitative Easing 2 (QE2) the five-year Treasury rate has only increased.   There are so many inflection points in future interest rate sooth saying it makes for a mad world.   The European Central Bank thinks inflation is an issue (in Europe).   Mr. Bernanke believes the beast to be well under control (in the U.S.).   Borrowers prefer low interest rates.  Saver’s prefer higher interest rates.  We are all very self-serving.

Inflationary Pressure Will Return

For the last five years we have become accustom  to mortgage interest rates being relatively stable.  Granted, underwriting standards have gone through a tornado and earthquake at the same time, but long-term interest rates have remained in a narrow band during this time.   Note to self:  this cannot continue forever.  Inflationary pressure will return (see recent rises in food prices) and interest rates will again see double digits.  

There is no method to predict when this will occur, however, we can  plan forward utilizing debt as a stabilizing force.  What does that mean?   It means that ownership and their management teams cannot pretend to be surprised at large swings in interest rates. 

Which Rates to Watch

Excluding times of hyper-inflation (seldom experienced in the U.S.) we are provided with notice of changes to the cost of  money.  Interest rates “trend” up and down.  Watch the Fed Funds Rate and  LIBOR (London Inter-bank Offer Rate).   Keep an eye on the 5-year Treasury.    Simple advice, yes, but consider this as an integral part of protecting the value of a multifamily portfolio. 

Consider that a one percentage point increase  in interest rates equates to $7,500+ per million dollars borrowed- per year.   Multiply this for a $100 million dollar portfolio and the impact is exponential!  It can really move the break-even point. 

Conventional wisdom is that having long-term fixed rates loans on income property solves interest rate exposure.  Not true.  Try finding a commercial mortgage fixed for thirty years.  This is a rare find today.  Whereas amortization may be for thirty years, the term of the fixed interest rate will be 3, 5 or 10 years.  

Stagger Mortgage Maturity Dates

There is nothing wrong with variable rate mortgages.  They have their place in a well-positioned portfolio.  They only become dangerous when over-utilized, when they represent a substantial portion of debt for a single owner/operator.   One simple method of spreading interest rate risks is to stagger maturity dates. 

Preservation of capital is home base.  It is the cornerstone of wealth.  Paying attention to interest rates and their impact on cash flow and value is part of protecting home base.

About This Blog
Multifamily Insight is dedicated to assisting current and future multifamily property owners, operators and investors in executing specific tasks that allow multifamily assets to operate at their highest level of efficiency. We discuss real world issues in multifamily management and acquisitions. This blog is intended to be informational only and does not provide legal, financial or accounting advice. Seek professional counsel. We discuss best practices in multifamily management and methods related to how to buy apartment complexes. Our focus is sharing strategies and tactics that can be implemented and measured. For more information, visit: www.MultifamilyInsight.com

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