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HYBRID CAPITAL - bLOG
WHY FINANCE YOUR PROPERTY IN 2015
Six (6) reasons to refinance your commercial property in 2015 - by Kevin Leung
Thinking about financing your real estate investment? Why not ring in the New Year with new financing? There has never been a better time for financing or refinancing your real estate investment. Today’s economic environment has the perfect conditions for property owners to grow their personal investments in real estate. While there are many reasons why you would want to finance your real estate investment, here are just a few good reasons to do so:
- Interest rates are at historic lows.
- Interest rates may begin rising by mid 2015.
- Hedge your cap rate
- Refinancing while banks are motivated to lend allows for a cash out at “maximum valuation” in a property’s current state.
- Empire-building at low cost
- Value-add strategies to maximize your property returns
1) Interest rates are at historic lows:
Interest rates are historically low. In the history of the Fed the Fed Funds interest rate has never been so low. Rates peaked around 19% in the 1980’s and the rate is now hovering between 0.12% - 0.13%. This Fed Funds rate affects all rates at which banks lend. Lower lending costs and falling government and corporate interest rates have made the search for yield challenging for lenders. This is fostering a very competitive lending landscape.
Figure 1. Federal Reserve Funds Rate over the last 40 years (Source: Federal Reserve)
Figure 2. United States Treasury Notes over the last 40 years (Source: Federal Reserve)
2) Interest rates may begin rising by mid-2015:
The Fed has indicated that the Fed Fund rate will rise, but when that will occur is not clear. According Bloomberg, “Fed Watchers” are predicting that the rate will rise by mid-year 2015. New York Fed President William Dudley stated that the consensus view of a mid-2015 Fed Funds interest rate rise is “reasonable.”
3) Hedge your capitalization rate:
Borrowers that already have loans in place could increase their return by refinancing at lower rates. Paying a lower interest rate will relieve pressure on their building’s capitalization rate (cap rate = Net Operating Income / Cost Basis or the Value of Property) and lead to a higher overall return. However when Fed Funds rates rises, cost of capital to all investors will also rise. Once the cost of capital increases, property values will be pressured; the prospective buyer’s return on investment will be negatively impacted by the higher cost of capital. Any reduction in property value or rise in net operating income results in a higher cap rate. Investors who refinanced today will be glad, since higher interest rates will put pressure on property values and the amount the investor may borrow.
4) Refinancing while banks are motivated to lend allows for cash-out at a robust valuation in a property’s current state:
Banks are required to lend in order to maintain their status. Currently banks are extremely motivated to lend to borrowers. At a time when building valuations are high (due to high demand for investment properties and cheap financing), banks are more willing to lend larger amounts to borrowers. Why? With low interest rates and high investor demand, property valuations are very strong. Refinancing during at a high valuation ensures that the borrower will maximize the amount they may borrow from the bank.
5) Empire-building at low cost:
Expanding your real estate portfolio has never been easier. By borrowing when financing is “cheap” (low interest rate) borrowers have the capability to expand their current real estate portfolio. Expansion can be achieved by drawing equity on a stable asset and borrowing at a low cost to purchase an additional asset. . Expanding your portfolio not only creates a larger asset base, but allows you to grow your property income through acquisitions. Although cap rates are currently low, the effect is offset by the extremely low cost of capital, particularly if pursuing a value-add strategy.
6) Value-add strategies to maximize your property returns:
By borrowing while loans are “cheap,” borrowers can potentially maximize their properties’ returns. Maximizing the property’s cash flow via improvement, renovation, or other value-add formulas is the best way to dramatically increase a property’s return when cap rates are low. By improving or renovating dated spaces, the property may attract higher quality tenants who are willing to pay a premium for a quality space. In the mind of many, newer equates to better quality.
Closing thoughts:
Taking on leverage can be daunting, but with the right plan and principled guidance, acting now will ensure you capitalize on these extremely uncommon market conditions. Interest rate environments like today’s are few, far between and fleeting. As the old saying goes, “luck is the point where preparation meets opportunity”. Now is the best time to take advantage of lenders’ enthusiasm.
Kevin Leung
Director | Hybrid Capital
Tel: 212-921-1555 x 103
Fax: 646-248-6111
Email: Kevin@hybcap.com