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ortgage brokers should understand how and why loans
have specific prices in order to steer their clients to the
best options. For lenders, the primary determining
factor for industrial real estate financing — beyond
property-level fundamentals such as rental income,
quality of the tenants and lease terms — is the index
that is linked to the loan’s maturity.
Libor is the commonly used benchmark index for
construction loans, while the index for permanent loans
is often the corresponding Treasury rate. A 10-year loan,
for example, will usually be priced with a spread based on the 10-year Treasury rate.
A five-year loan, then, will often be based on the five-year Treasury rate. And a short-term construction loan — which is often funded monthly during the construction
phase — may be priced using the 30-, 60- or 90-day Libor rate. In a typical financing
environment, the cost to borrow increases as the underlying index rate increases.
Reasons for rising costs
We are currently in a rising interest rate environment. Assuming lenders maintain their
underwriting criteria, it will become more expensive to borrow and loan proceeds may
be reduced. Libor rates increased approximately 100 basis points over the 12 months
ending this past September, while the 10-year Treasury rate increased about 80 basis
points over the same period.
Borrowers need to be aware of this dynamic as an index may rise substantially from
the time of the original underwriting to closing. As a result, borrowers may end up with
more expensive financing than what was underwritten, smaller loan proceeds or both.
One critical factor to understand is the probability of an inverted yield curve in the
near future. An inverted yield curve exists, for example, when the two-year Treasury rate
is more expensive than its 10-year counterpart. In simple terms, this means that fixing
long-term debt when the curve is flat or inverted may actually be less expensive than a
The yield curve seems to be headed toward an inverted trajectory by the end of this
year or early in 2019. As a result, there is very little benefit today to financing an industrial
real estate acquisition with a floating-rate loan or a short-term bridge loan, provided
the lender offers flexible prepayment penalties. Although less-expensive interest rates
may be great news for borrowers with stabilized assets who want to hold them for the
long term, it’s worth noting that the inverted yield curve also has preceded every U.S.
recession since 1960.
Mortgage brokers and borrowers who understand the economics behind interest
rates should next know about three primary sources of debt for the industrial real estate
sector. These include traditional banks, life insurance companies and the commercial
mortgage-backed securities (CMBS) market.
Banks get competitive
Historically, the traditional sources for many industrial-property loans are community,
regional and national banks. Many banks today can offer a wide variety of financing
options, from long-term fixed-rate loans to short-term bridge loans and, depending on
the bank’s size and credit policy, even construction loans.
In the past 24 months, banks have become more accommodating to borrowers through
their financing terms as they attempt to win business in a competitive environment. That
being said, as a group, banks are more conservative today than during the last real estate
cycle and appropriate underwriting standards continue to be in place. It seems banks —
and hopefully borrowers, too — remember the difficult lessons learned during the Great
Recourse is a main differentiator between banks. Simply put, some banks require
personal recourse and/or loan guarantees to approve financing, whereas others are
willing to provide lower-leverage loans on a nonrecourse basis. This poses some
philosophical questions for both lenders and borrowers to consider: In essence, is it
appropriate, given the property-level fundamentals, to make a nonrecourse loan to a
borrower? And, in the same vein, should a borrower take out a loan they can only obtain
by allowing lender recourse?
Each lender and borrower will need to determine their risk tolerances and the right
answer may be different depending on the situation. But, by and large, signing a recourse
provision will tend to result in either higher leverage, a lower interest rate or both.
criteria, it will