When rates rise, apartment building lenders are really concerned with two things: (1) Will rising rates depress the future value of the subject collateral? (2) How do I take advantage of higher future rates to increase my return on the loans I make?
As interest rates rise, property cap rates should rise with them. All things being equal, this will cause the value of an apartment building to go down. In an effort to mitigate the risk of a property’s value declining and ending up over-leveraged if NOI does not increase, many lenders are dialing back how much loan dollars they will give on any investment. If they were willing to give out 75 percent loan-to-value on acquisitions when rates were stable, now maybe they have moved down to 70 percent loan to value. Ultimately what this means for an investor is coming to the table with more upfront dollars and a lower return on the dollars invested. Coming in with an extra 5–10 percent may not be the end of the world, but for many properties that were being sold for top dollars and tight margins, that could make a big difference in whether or not the investment makes sense.
Many apartment building lenders are also looking at rising rates as an opportunity for them to capture more yield on their loans. This can be a difficult task, however, since most investors are going to demand a fixed rate. If a lender can offer a swap, it can be an attractive way for them to see upside as rates rise. But many borrowers do not qualify for them and some that do push back on doing swaps. What many lenders do instead is simply hold off on offering long-term fixed rates and instead offer short-term fixed rates in an effort to see short- to medium-term rate adjustments on their loans. What this means for investors is that they are going to find many more short-term fixed-rate options in the market as opposed to long-term, 10-year fixed products.
The lenders most likely to get conservative in a rising-rate environment are going to be banks and other depositories. They are heavily regulated and often need to be ahead of the curve in risk management or they can end up explaining themselves to the FDIC later down the road. Investors should be aware of this when looking for loans today and be certain to explore non-bank lending options, especially through government agencies. Investors with small property loans under $1 million may not have many loan options with these types of non-bank lenders, but investors with loan amounts over $1 million per property will be able to take advantage of much more competitive options.