Another quarter has come and gone with inflation continuing to persevere driving speculation on Fed moves in the future. This impacts current interest rates and our borrowing decisions. Where do we go from here? Please enjoy our quarterly newsletter discussing these themes, their impact on your business, and more.
COMMERCIAL REAL ESTATE NEWS
Braving the Debt Restructuring Minefield
Many property owners are stunned to learn that they are facing significant cash paydowns to renew or extend their maturing commercial real estate mortgages even though their properties are performing. One root of this problem is the gradual shift from utilizing the Debt Yield test to applying the Debt Service Coverage Ratio test.
Article courtesy of Commercial Property Executive – Full Article Here
What to Know About Tax-Aware Borrowing
Individuals can choose to take out loans in a way that may minimize their tax liability – this is called tax-aware borrowing. Learn more about it.
Article courtesy of J.P.Morgan Insights – Full Article Here
MSCI: Multifamily property price decline continues
The latest commercial property price report from MSCI Real Capital Analytics said that multifamily property prices fell 1.0 percent from their level of the month before in February. This is much faster than last month’s reported decline of 0.4 percent. Prices were down 8.9 percent from their level of one year before.
Article courtesy of Yield Pro – Full Article Here
ECONOMIC DATA
BORROWER EDUCATION
The Fed’s Balance Sheet and Long Term Rates
We were recently asked a question about the Federal Reserve’s (Fed’s) balance sheet reduction program and what it means for rates. When the Fed raises or lowers interest rates, it directly impacts short-term rates, like the federal funds rate. However, the effects on long-term rates, such as those for mortgages and corporate bonds, are more complex and depend on several factors.
Short-Term Rates: The Fed’s target rate range currently sits between 5.25%-5.50%. Banks use this rate as a base for lending rates, with the prime rate typically set at the Fed rate plus 3%. This is why the prime rate, which many consumer loans are tied to, is currently at 8.50%. As Prime changes, the rate on many loans changes. Many loans that are shorter term or revolving (SBA 7(a) variable rate loans, operating lines of credit, credit cards or HELOCs) have rates directly or loosely based on Prime.
Long-Term Rates: Long-term rates, on the other hand, are driven by market forces and influenced by factors like supply, demand, and expectations of future short-term rates. Investors consider the expected future path of short-term rates when pricing long-term debt, factoring in a risk premium for holding the investment over a longer period. This relationship is illustrated by the yield curve, which plots interest rates across different maturities. However, when the market expects short-term rates to decline in the future, as it does currently, it can lead to an “inverted yield curve,” where short-term rates are higher than long-term rates.
Supply and Demand: While market expectations play a role, long-term interest rates are also heavily influenced by supply and demand dynamics in the debt markets. Prices and yields of long-term debt instruments are constantly adjusting based on the balance between buyers and sellers. If there is a lack of demand for a particular debt instrument, sellers may need to offer higher yields (lower prices) to attract buyers. Conversely, if demand exceeds supply, buyers will bid up prices, leading to lower yields.
The Fed’s Role: The Fed’s balance sheet reduction program plays a significant role in long-term rate determination. During the COVID-19 pandemic, the Fed was a major buyer of U.S. Treasurys and mortgage-backed securities, creating demand and keeping long-term rates low. Now, as the Fed allows these securities to roll off their balance sheet without reinvesting the proceeds, sellers must find other buyers, potentially needing to increase yields to entice demand. If the Fed were to actively sell these securities, it could flood the market with supply, further driving up long-term rates.
Recent Rate Influences: Currently, the market expects the Fed to lower short-term rates by the end of 2023. However, the Fed has signaled fewer rate cuts in 2025 and 2026, which could increase long-term rates by changing the expectation of future short-term rates. Additionally, the U.S. Treasury Department’s continued issuance of new debt to fund government spending puts upward pressure on yields, as more supply must be absorbed by the market rather than by the Fed.
Looking Ahead: While the Fed may aim to lower short-term rates to provide relief to consumers with variable-rate debt, it may not attempt to lower long-term rates as aggressively. This could create a more “normal” yield curve, with short-term rates below long-term rates. It’s important to note that our perception of “normal” rates has been skewed by the prolonged period of exceptionally low rates. In the early 1990s, mortgage rates declined to around 7-8% sparking a refinancing wave, illustrating how rate expectations can shift over time.
RECENTLY FUNDED TRANSACTIONS
Here are examples of opportunities we assisted our clients with last quarter:
- $13,375,000 Four Medical Practices Purchase – Las Vegas, NV and Kennewick, WA – 100% LTV
- $715,000 Four Unit Multifamily Refi – Moses Lake, WA – 74.48% LTV
- $1,575,000 Equipment Purchase – 78.75% LTV
Contact us to learn how we can help you with your commercial property financing.
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