No one can predict the future, but you can prepare for it.
That’s always good advice for investors seeking to refinance their multifamily properties, but it’s particularly apt now. There’s both change and volatility in the air, making planning imperative.
Volatile Interest Rates
Interest rates have remained at historic lows much longer than most analysts predicted five years ago. Upward pressure has been restrained by a combination of factors that include a slower-than-expected recovery, the strong U.S. dollar and a fight to quality by global investors.
However, in December the Fed raised rates for the first time in a decade, albeit modestly. Market observers expect additional increases this year.
Meanwhile, investors remain concerned about interest-rate volatility. Last February, the yield on the 10-year Treasury note dropped to 1.68 percent. In June, it rose to 2.50 percent. October saw a dip to 1.99 percent, followed by a November high of 2.34. In the last 12 months, it has not been unusual to see rates jump 20 to 30 basis points in the course of a week. For an investor, the significance of that rise can be measured in the difference between securing a $10 million loan and settling one that’s just $9 million.
Both the change in interest rates and their volatility are subject to forces that are impossible for investors to anticipate. They include everything from unseasonable weather and natural disasters to new disruptive technology such as fracking, and that old perennial, geopolitics.
In the summer of 2014, there were undoubtedly very few multifamily investors with the forethought to anticipate the effects of a very cold winter on economic activity during the first six months of 2015.
Uncertain Access
Investors face other issues besides interest rates; events of this past year have underscored the need for investors to concern themselves with the availability of financing. Right now, there is a great deal of competition among lenders for clients.
The agencies, banks, CMBS conduits and life companies are all active, particularly on the coasts. The competition is less intense in the middle of the country, but even in these areas, lenders are pricing aggressively.
This contrasts with the slowdown in agency lending we experienced in the spring of 2015. Having exceeded their yearly cap in the first four months of 2015, Fannie Mae and Freddie Mac raised their loan spreads to slow originations, giving the Federal Housing Finance Agency (FHFA) time to consider its options.
Going forward, FHFA defined affordable housing — one of the categories excluded from the cap — in ways that increased the number of exempt units excluded from the cap. And while the agencies continued to finance Class A properties, especially for repeat customers, they tended to look favorably for the remainder of the year on borrowers who included affordable housing in their mix.
Here again, it would have taken an impossibly astute investor to anticipate these developments. In both cases, prudence dictates that investors seeking to refinance prepare for events they cannot anticipate. The best way to do this is to take an early look at your portfolio.
Act Early
Borrowers should start thinking about the properties they want to refinance at least 18 to 24 months before their loans mature and, ideally, to plan on refinancing maturing loans at least a year in advance.
This gives investors the leeway to postpone their refinancing if the economic stars are not aligned, an option that would be unavailable if they had waited until the last minute to act.
Borrowers should also consider early rate lock. Early rate lock allows an investor to kill two birds with one stone. It enables them to take their interest rate risk off the table, while allowing them to continue burning off the prepayment penalty on their existing loan.
The agencies allow you to early rate lock up to 12 months in advance. The early rate lock calculation can be a complicated one. Investors must balance the advantages of securing their target rate and reducing their prepayment penalty against paying a higher spread, all in the context of their view of interest rate trends.
Think of early rate lock as an insurance policy with some worthwhile provisions. The 5 percent cushion built into the agencies’ early rate lock program means that lenders can increase or decrease the loan amount without breaking the rate lock.
In addition, getting a jump on refinancing 18 to 24 months ahead of the maturity date on an existing loan gives investors the opportunity to put their financial house in order.
Lenders pay special attention to an investor’s financials over the trailing 12-month period before they submit their application for refinancing. Borrowers should do their best to tell an appealing story.
They should take steps to maximize their net operating income, raising rents if occupancy levels warrant it. They should review their property’s current operations in detail and look for ways to minimize expenses, such as any signs of over-staffing, higher than necessary advertising, etc. And they should address charge-offs for bad debts.
Finally, getting an early start on refinancing will put borrowers in the position to expedite the process of preparing their loan documentation. They can use the time to update their personal financial statements and real estate schedule.
The bottom line: Given the inevitable uncertainties in the capital markets, borrowers should do everything they can to maximize the flexibility and speed with which they can react to unforeseen events, both good and bad. Preparing early is the key.
— By Brian Sykes, senior vice president of loan originations with Capital One.