{"id":1004354363,"date":"2019-09-27T06:39:34","date_gmt":"2019-09-27T14:39:34","guid":{"rendered":"https:\/\/www.commercialsearch.com\/news\/?p=1004354363"},"modified":"2022-12-08T21:03:05","modified_gmt":"2022-12-09T05:03:05","slug":"the-fixed-rate-vs-floating-rate-dilemma","status":"publish","type":"post","link":"https:\/\/www.commercialsearch.com\/news\/the-fixed-rate-vs-floating-rate-dilemma\/","title":{"rendered":"The Fixed-Rate vs. Floating-Rate Dilemma"},"content":{"rendered":"

With the Federal Reserve continuing to push down interest rates, it would seem that investors should pin down low capital costs while they can. But current dynamics in the still frothy debt and equity markets tell a more complex story.<\/p>\n

READ THE DIGEST VERSION<\/a><\/p>\n

\"Joseph<\/a>

Joseph Iacono, CEO of Crescit Capital Strategies, warns that a short-term fixed-rate strategy is not the best way to protect a property from increasing interest rates. Image courtesy of Crescit Capital Strategies<\/em><\/p><\/div>\n

Despite more cautious predictions at the beginning of the year, investment activity seems close to matching 2018. High transactions volume has been supported by increased liquidity in the equity and debt markets<\/a>\u2015mostly private capital. According to a recent Cushman & Wakefield capital markets report, capital availability in the lending environment for the second half of 2019 is expected to \u201cremain elevated with multiple lender groups active and greater competition between fixed- and floating-rate execution.\u201d<\/em><\/p>\n

Current investment trends keep demand for floating-rate loans high, a financing tool that has been traditionally viable for short-term holders. \u201cThere is a lot of capital chasing value-add deals that lend themselves to a floating-rate execution. Also, the commercial real estate collateralized\u00a0loan\u00a0obligations market has created demand for shorter-term floating-rate paper. The proportion of floating-rate executions is definitely increasing,\u201d<\/em> said Shaunak Tanna, head of structured finance at Basis Investment Group.<\/p>\n

In July, the Federal Reserve cut interest rates by 0.25 percent for the first time in a decade to a range of 2.00 to 2.25 percent<\/a>. While the decrease will benefit both fixed-rate and variable rate borrowers, it is definitely time to pin down historically low rates on stabilized properties, especially when the intention is to hold them for the long-term. Michael Campbell, CEO of private equity banking firm The Carlton Group, expects to see an increase in fixed-rate loans, which require a well thought out approach, particularly in today\u2019s volatile environment.<\/p>\n

\u201cIf your property qualifies for long-term fixed-rate loans, then this is a good time to lock in lower rates. But it\u2019s worth noting that while benchmarks may go lower, we may see some spreads widening, which offsets some of the reduction in benchmark rates,\u201d<\/em> said Joseph Iacono, CEO of commercial real estate debt provider Crescit Capital Strategies.<\/p>\n

When it comes to short-term fixed-rate executions, things can get tricky. Demand for this type of financing products is on the rise due to more affordable costs, but lenders warn that, in the end, this might not even be an efficient way to protect properties from the possibility of rising rates down the road. Iacono believes that borrowers in this category will find themselves in the market for a refinancing soon enough when the initial loan matures and will be subject to that particular rate environment. Therefore, lenders agree that for properties that are \u201cin transition\u201d (from one owner to another) and require bridge financing, the floating-rate market provides better solutions.<\/p>\n

Low rates, high risks<\/h2>\n
\"The<\/a>

The Carlton Group CEO Michael Campbell says that this is the best time for long-term holders to pin down historically low rates on stabilized properties. Image courtesy of The Carlton Group<\/em><\/p><\/div>\n

The overall expectation is that more interest rate cuts\u2014anticipated from the Fed by year-end\u2014will lead to a lower cost of debt, but experts claim there\u2019s more to this. \u201cOn floating-rate, we expect to see the London Interbank Offered Rate decline over time. The LIBOR curve clearly indicates that this is the market view. We expect spreads to move up to compensate for market risks given the heightened uncertainty. Borrowers may not get the full benefit of declining rates if spreads move in the other direction,\u201d<\/em> added Tanna.<\/p>\n

Regarding the elimination of the LIBOR index, the market has yet to reach a conclusion on how it will all play out. Some expect a smooth transition to the Secured Overnight Financing Rate and expect minimal impact on debt cost since the new index is based on the heavily traded Treasury market. Others are not yet sure how different spreads will react to it, since there haven\u2019t been enough issuances tied to SOFR yet. In theory, LIBOR pricing factors in the credit risk premium. SOFR, on the other hand, does not, since it is based on the repo market. In this case, too, more time is needed to grasp the potential impact of the new benchmarks on debt cost and to develop the right tools to mitigate additional risks.<\/p>\n

\u201cIt is possible that banks offering shorter-term fixed-rate products will compete better (after the swap). Capital markets lenders will have their costs tied to SOFR, so they will continue to offer loans with SOFR as the benchmark. We expect tools currently available to hedge LIBOR risks\u2014swaps and caps\u2014will be available to hedge SOFR risks, too,\u201d<\/em> said Tanna.<\/p>\n

Unknowns ahead<\/h2>\n
\"Shaunak<\/a>

Shaunak Tanna, head of structured finance at Basis Investment Group, backs up defensive and diversified \u201cdequity\u201d strategies as a hedge against a turning cycle. Image courtesy of Basis Investment Group<\/em><\/p><\/div>\n

There are several macroeconomic factors that are affecting the real estate debt market right now, including the inverted yield curve, fears of a recession, decreasing condo prices, increasing multifamily supply in certain markets, as well as the trade discussions with China and the protests in Hong Kong due to the controversial extradition bill, Campbell noted. Even though Hong Kong leader Carrie Lam announced she would withdraw the bill, causing the 10-year Treasury yield to climb above the two-year rate, experts believe that this is not the end of the turmoil in the region.<\/p>\n

\n

READ ALSO:<\/strong>\u00a0Balancing Access, Risk in Today\u2019s Flush Debt Market<\/a><\/p>\n

\n

In fact, the \u201ctrade war\u201d between the U.S. and China is considered the single biggest risk for economic growth and stability right now, leading to elevated expectations of a recession. The best strategy in this case is based on flexibility and diversity.<\/p>\n

\"Spread,<\/a>

Source: Federal Reserve Bank of St. Louis, CBRE, August 2019<\/em><\/p><\/div>\n

\u201cDefensive and diversified \u2018dequity\u2019 strategies are expected to outperform in this market. The basis in real estate and the position in the capital stack will differentiate the winners when the cycle turns. Investors that rely on market rent growth or appreciation through cap rate compression will be disappointed. We believe realized returns in the \u2018dequity\u2019 space will be similar to or may even exceed equity returns, for a lot less risk,\u201d<\/em> said Tanna.<\/p>\n

What lies ahead is harder to predict, as actions of other central banks may drive the U.S. 10-year yield even lower. At the same time, a trade-war resolution would clear the clouds and may result in the 10-year yields moving up.<\/p>\n

\u201cMacroeconomic uncertainty has caused the 10-year rate to be close to its all-time lows. But the U.S. still continues to be among only a handful of developed nations that have a positive yield. It\u2019s tough right now to predict a direction as many political and macro-economic factors are in play,\u201d<\/em> Tanna concluded.<\/p>\n

\u201cThere\u2019s currently a lot of uncertainty in the market. The effects of a potential economic slowing will likely be felt on the demand side for real estate,\u201d<\/em> added Iacono.<\/p>\n

Read the October 2019 issue\u00a0of CPE.<\/em><\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Locking in low interest rates may not be enough to protect your property from a rise in debt costs.<\/p>\n","protected":false},"author":236,"featured_media":1004357384,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[1521,21825,45527,23891],"tags":[47114,35264],"class_list":["post-1004354363","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-digital","category-finance","category-keyword-optimized","category-national","tag-basis-investment-group","tag-the-carlton-group"],"acf":[],"yoast_head":"\nThe Fixed-Rate vs. Floating-Rate Dilemma - Commercial Property Executive<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.commercialsearch.com\/news\/the-fixed-rate-vs-floating-rate-dilemma\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"The Fixed-Rate vs. Floating-Rate Dilemma\" \/>\n<meta property=\"og:description\" content=\"Locking in low interest rates may not be enough to protect your property from a rise in debt costs.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.commercialsearch.com\/news\/the-fixed-rate-vs-floating-rate-dilemma\/\" \/>\n<meta property=\"og:site_name\" content=\"Commercial Property Executive\" \/>\n<meta property=\"article:publisher\" content=\"https:\/\/www.facebook.com\/CPExecutive\" \/>\n<meta property=\"article:published_time\" content=\"2019-09-27T14:39:34+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2022-12-09T05:03:05+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/www.commercialsearch.com\/news\/wp-content\/uploads\/sites\/46\/2019\/09\/interestrate.jpg\" \/>\n\t<meta property=\"og:image:width\" content=\"800\" \/>\n\t<meta property=\"og:image:height\" content=\"620\" \/>\n\t<meta property=\"og:image:type\" content=\"image\/jpeg\" \/>\n<meta name=\"author\" content=\"Alexandra Both\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:creator\" content=\"@cpexecutive\" \/>\n<meta name=\"twitter:site\" content=\"@cpexecutive\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"WebPage\",\"@id\":\"https:\/\/www.commercialsearch.com\/news\/the-fixed-rate-vs-floating-rate-dilemma\/\",\"url\":\"https:\/\/www.commercialsearch.com\/news\/the-fixed-rate-vs-floating-rate-dilemma\/\",\"name\":\"The Fixed-Rate vs. Floating-Rate Dilemma - 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