Jeff Huhn, BridgeTower Media Newswires
Responding to the constant predictions of rising interest rates has been like hitting the snooze button on a Monday morning. For commercial property borrowers, this may now be the time get up, hit the showers, and rush into work before the boss arrives.
The US economy officially exited the Great Recession in June of 2009. At that time, the major index rate for commercial loans, the Federal Home Loan Bank Advance Rate, was 3.59 percent for the five year fixed rate, resulting in the rate paid borrowers of 5.34 percent to 7.34 percent after adding the typical bank margin of 1.75 percent to 3.75 percent.
A funny thing happened after we emerged from the recession. Interest rates went down. Way down. Arguably, it was those low rates that kept the economy from dipping back into a recession and has ultimately contributed to the economic growth we are currently experiencing.
If you were borrowing against commercial property in 2009 and locked in a five year fixed rate, when that rate reset in 2014, your borrowing cost likely decreased by over 1.50 percent. On a $5,000,000 loan, that represents an initial annual savings of nearly $75,000.
When that five year rate resets again in 2019, however, rates will likely be higher. As an example, from 2013 to 2018, the Federal Home Loan Bank Five Year Advance Rate is up over 2.00 percent. On that same $5,000,000, your initial annual interest expense would have increased almost $100,000.
What are your options when you receive the loan statement with your new higher interest rate?
If you are a commercial real estate investor, you can pass along the higher interest cost through higher lease rates. That strategy, however, depends on when the leases renew and your tenants’ ability to pay the higher rates. If you are a business that owns its own building, those higher interest costs come directly out of your bottom line.
Another option is to call your banker and request a lower interest rate. The banker’s initial response may be a simple reminder that you signed a promissory note and deed of trust; in other words, declining your request. Your leverage in this case would be to refinance the loan with another bank, playing on your banker’s fear of losing a client. Keep in mind, if you refinance with another lender, you would incur new costs for appraisals, environmental risk assessments, title insurance, and loan fees, which could wipe out the benefit of a lower interest rate.
If your rate does not reset for another year or two, you may want to proactively approach your bank about locking in a fixed rate now. You may also work with your bank to “re-amortize” your loan, essentially refinancing your loan with your existing bank. This may result in lower payments, even with a higher interest rate, because you are taking advantage of a lower principal balance on your loan after years of payments and now stretching the repayment of the remaining loan balance over a longer period of time. This may be a great option if you plan to sell the property in the next few years while maintaining your level of net cash flow.
One other option, albeit riskier, is to switch to a lower variable rate instead of a fixed rate. The 30 day Libor Rate is currently 1.94 percent. With an additional margin of 2.50 percent, the variable rate would be 4.44 percent. If that same 2.50 percent margin is added to the five year Federal Home Loan Bank index, the rate would be 5.68 percent. If you don’t quite have the risk tolerance for a floating rate loan, consider taking a portion of your loan and fixing the interest rate while having a variable rate apply to the rest.
Additionally, if your bank offers interest rate swaps, at any time you could “swap” the variable rate for a long term fixed rate, meaning the bank will continue to receive a variable rate while you pay a fixed rate and a third party assumes the market interest rate risk. Interest rate swaps are a sophisticated financial instrument and carry inherent risks, but may be worth a conversation with your banker if you plan to keep the building during the life of the loan.
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Jeff Huhn is Boise metro market president at First Interstate Bank. He can be reached at jeffrey.huhn@fib.com.
