As The Yield Curve Tightens Financing Decisions Get Tricky

NEW YORK CITY–The spread between the 5-year and the 10-year Treasuries is the tightest it has been since August 2007, resulting in all-in commercial real estate borrowing costs that are nearly indistinguishable at different terms. A year ago the spread was about 50 basis points, Cushman & Wakefield Managing Director Chris Moyer tells GlobeSt.com. Today that spread is around 15 basis points. The result has been borrowers opting for longer-term money because, after all, there is no real savings benefit to taking out a five-year loan, regardless of the deal at hand.

Here’s the issue though, Moyer says: For shorter-term deals, in five or seven years the borrower may sell the properties and now he has three to five years remaining on the loan term. “Depending on where interest rates are at the time and depending on the leverage of the loan, there could be a substantial cost or impairment to the value of the real estate because of the liability of the loan,” Moyer says.

Much depends on where interest rates will be in that five to seven year period of course. Let’s say a borrower took out ten-year money at 4.5% and sold the property in five years. “If you can borrow five-year money for 4% in five years people will view that 50 basis points as effectively a ding against value,” he says.

On the other hand if interest rates go up further there is the potential that the financing could be an asset. “The borrower is not taking an interest rate risk because he’s locked in at a ten-year rate. But he is inherently playing the fixed-income interest rate market in some capacity because he is tying up long-term debt,” Moyer says.

Interest rates, as of this point in the cycle, are clearly going up. That too is affecting financing decisions, Moyer says. C&W’s Capital Markets Update noted that as interest rates continue to rise, some borrowers are taking less financing to avoid negative leverage on low cap rate deals. This is particularly true in tight cap rate markets like New York, Los Angeles and Washington DC, where office or multifamily caps are in the 4% range, Moyer says. Borrowing costs, meanwhile, are in the low to mid 4% range. “So if you’re buying a deal at those types of cap rates your debt is costing you more than the NOI that the property is throwing off. So you effectively take a negative leverage.”

What C&W is seeing for low rate cap deals is either the borrower not taking on debt at all, or taking only very low leverage where the debt is at or below the cap rate, Moyer says.