Interest Rate Increases Impacts Real Estate Mortgage Loan Proceeds
Submitted by A. Adams
The mortgage interest rate market has a significant impact on loan underwriting and property valuation for commercial real estate. The United States has adopted an accommodative interest rate policy for the last eighteen months. The Federal Reserve, based upon the United States weak economic results, has kept interest rates at historic lows.
One of the vehicles that the Federal Reserve is using in its Quantitative Easing Program to keep interest rates low is to purchase $85 Billion in US Treasuries every month. As noted on the cartoonists view included below, the Federal Reserve Chairman, Ben Bernanke, made a speech a week ago in which he announced that, based upon a number of “what-if” scenarios, that the economy is improving slightly and that the Federal Reserve may consider reducing the Treasury acquisitions in the near future. This announcement had the impact of significantly reducing the stock market, but also had an impact of dramatically increasing interest rates. One of the results of this announcement is that over $76 billion has been withdrawn from the bond funds due to the concern of rising interest rates. This number represents two times the bond funds withdrawn during the 2008 financial crisis.
One of the key indices used in pricing the commercial mortgage interest rates are the U.S. Treasuries. More specifically, the 10 year Treasury is utilized for long term fixed rate pricing. As indicated below, the 10 year Treasury was as low as 1.41% in July 2012. As of June 19th, 2013 the rate had increased to 2.17% and with the announcement by the Federal Reserve last week increased the Treasury as high as 2.57%.
| 7/23/12 (Lowest) 6/19/13 6/27/13 Basis Point Increase
5 Year Treasury .55 1.05 1.45 40 10 Year Treasury 1.41 2.17 2.57 40 Sample Lender Interest Rate 4.77% 5.17% 40 |
As noted above, the Treasury rates increased 40 basis points due the announcement from the Federal Reserve and the largest multifamily lender in the country increased their interest rates by 40 basis points as well.
The increase in interest rates, as mentioned above, has a direct relationship to the underwriting and the valuation of commercial real estate. The results, for example of a 40 basis point increase in interest rates, impacts the debt payments and the loan proceeds available to the client. For example, based on the following assumptions, our loan proceeds will be affected as follows:
| Assumptions: | Net Operating Income | $1,000,000 |
| Loan Amortization Period | 30 Years | |
| Debt Service Coverage Ratio | 1.20 |
| Prior to Federal | After Federal | |
| Reserve Speech | Reserve Speech | |
| Interest Rates | 4.77% | 5.17% |
| Loan Proceeds Supported | $13,290,803 | $12,683,916 |
| Reduction of Loan Proceeds | $706,886 |
As borrowers and lenders in the commercial mortgage industry, we are hoping for less dramatic increases and decreases in interest rate policy and market movements. In any event, the general opinion is that interest rates will continue to increase and it is a great time to lock in commercial mortgage interest rates.