The Federal Reserve has raised interest rates a total of 225 basis points in the last six months to combat inflation, which is running at a 40-year high. Central banks around the world have spent recent weeks following suit with increased interest rates. Rate hikes, which affect the cost of borrowing money, have increased from a near-zero number to a range of 2.25%-2.50%. This last week the Fed made an unprecedented fourth rate hike in five months. Economists are predicting another 1.5 percentage points or more in interest rate hikes before the end of the year. With interest rates on the rise, banks have now altered how they underwrite deals. Banks are now underwriting deals with larger debt coverage ratios (DCR), increased structural reserve budgets, and less leverage. Banks have also been seen sitting on the sidelines and are quite hesitant to lend on significant value-add or new development projects. Even though banks and financial institutions are in a better position now than they were in 2008 they will still be weathering the storm and pulling back on overall financing expansion.
For investors and small businesses that are taking on debt in the current market, they need to understand that most loans are variable rates, which means interest rates adjust on a quarterly basis as the underlying index rate adjusts. On a positive note, in the next 12-18 months economists and analysts are predicting that interest rates will be “back to normal” as they were before the beginning of 2022. We don’t think they will go that low that fast, however, there should be some decline in the interest rate environment.
Also, on a positive front, space is still in high demand throughout the country as tenants continue to expand primarily in industrial, multi-family, retail, and healthcare assets. With inflation dramatically increasing the material costs for new development projects, there has been a drastic downtick in ground-up development since the last cycle. Thus, is a positive for the market because tenant space is still in high demand without production coming online for a few more years.
Please remember what goes up, comes down, and vice versa. Investors/borrowers ‘date their rate’ meaning, this is temporary. So, if an investor can obtain a loan, float the rate, and then fix the same when rates come down, they will be in an advantageous position to transact in today’s environment. Also, the equity requirements might change slightly, but we are not seeing a drastic difference in the leverage amounts.
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