Commercial Lending Gets Creative as Interest Rates Rise

The prime rate is at 7.75%, its highest level since October 2007.

This means bank loans are becoming harder to get and increasingly under more scrutiny. Consequently, commercial projects that might have been rapidly approved just two years ago aren’t getting done. Real estate companies across the country, particularly those specializing in multi-family housing, have been especially hard hit at a time when demand for affordable homes is extremely high. The result is less and less capital available for these types of projects.

This has several implications for investors in the office, industrial, retail and multi-family sectors:

• When thinking about a new property to purchase, consider whether there is already an assumable loan in place. They are very attractive right now. Savvy real-estate investors are seeking out and purchasing such properties financed before March 2022, when the prime rate was 3.25%. With these loans, buyers can assume the lower interest rate, while sellers may be able to bypass prepayment fees.
• Higher interest rates make it important to consider different ways to structure loans. For example, if a property purchase or refinance is in the works, the borrower may be able to negotiate a rate cap with the lender to limit how high the interest rate will increase when the loan has a variable rate. Or, the borrower may be able to convert the loan to a fixed rate if certain triggers are met that are included in the loan agreement.
• Increasing rates can constrain the amounts available because lenders use metrics like loan-to-value ratios and debt-service-coverage ratios to size loans. If debt payments increase with no boost in revenues used to repay the loan, the total loan amount must be reduced to meet the required ratios. Higher rates ultimately can put pressure on an owner’s ability to finance a real estate project. There are many groups that specialize in deploying joint-venture limited-partner equity, preferred equity, or mezzanine financing that can help round out the capital needed when purchasing or refinancing a property.