Let’s take a look at the yield curve, which highlights the relationship between interest rates and maturities. A sharply positive curve often indicates growth, with the potential for inflation. An inverted yield curve, with short-term rates higher than long-term rates, suggests a slowing economy with little likelihood of inflation. The current yield curve plotted in the accompanying graph is relatively steep slope, showing the potential for inflation risk.
Credit Risk Spread
Credit spread, the second component of commercial mortgage interest rates, is affected by property-level metrics and macro-level economics. As gross domestic product grows at an accelerating pace and unemployment decreases, bond investors’ appetite for commercial real estate paper increases. Conversely, there are national and international events that push credit spreads higher.
The depreciation in the housing market in 2008 created a marketwide knee-jerk reaction. CMBS (commercial mortgage-backed securities) bond buyers were terrified of investing in commercial real estate, and spreads on those bonds skyrocketed from 30 bps to nearly 1,200 bps (see the accompanying graph). So clearly, market shocks can play a role in determining credit risk spread.
In addition, property- and borrower-specific drivers affect the credit spread. For instance, the leverage of the loan, the location of the real estate, the consistency of the income stream, the experience of operator, and the strength of the sponsor all have an effect.
Experts will offer their opinions about the future of interest rates, but it's very difficult to determine whether the current period of low rates is just an abnormal dip or, in fact, the “new norm.” If you conclude rates are abnormally low and will likely increase, it would be wise to lock in long-term, fixed-rate financing today. If you believe we have entered a new era in which rates are permanently low and could even go lower, it may be wise to wait and see.
Even for those who believe rates will remain low, there is 10-year, fixed-rate debt available with no prepayment penalty, creating a nice hedge against higher rates, while allowing for early refinance if rates decrease. Just remember: Even after considering all of the factors, your prediction will still be as reliable as that of a sportscaster predicting the winner of a game.
Devin Huber is a principal at The BSC Group, which offers financial and loan advisory, mortgage-brokerage and loan-workout solutions to commercial real estate property owners and investors, with a special emphasis on the self-storage market. Prior to helping found The BSC Group, Huber was a senior vice president at Beacon Realty Capital and a key member of the firm’s Self Storage Group. To reach him, call 800.605.7880; e-mail firstname.lastname@example.org; visit www.thebscgroup.com.