Today, there is over $5 trillion in commercial real estate (CRE) debt – and the total debt is rising. As CRE firms and the industry as a whole take on more debt, minimizing risks and maximizing returns in your portfolio will require accurate, proactive debt management. In the current shifting CRE landscape, debt management is the next lever that firms can optimize to more effectively understand and drive favorable results in their portfolio’s performance. But, how can you develop a solid debt management strategy in an unpredictable market?
In our recent webinar, Strategically Optimizing CRE Debt in a Changing Market, we discussed current shifts impacting commercial real estate, why debt management is key in mitigating portfolio risks, and strategies for optimizing debt management today. Panelists Kevin Swill, CEO of Thirty Capital Financial, and George Cline, Co-Founder of Ardent Equity Group, shared insights and strategies concerning how to navigate debt in a changing landscape
Watch the webinar to hear the full conversation. Or, read ahead for an overview of the discussion.
Commercial Real Estate Market Shifts
The CRE market is constantly evolving. Today’s market shifts are impacting every facet of commercial real estate, including debt management. During the webinar, we outlined three causes of today’s market shifts and their effects on the industry
- Increasing interest rates
- Rising cap rates
- Rising cost of labor and goods
- More expensive to acquire or refinance new assets
- Lower asset values
- Increasing operating expense
Ultimately, these changes are impacting projected returns for both the sponsors and the investors. As you navigate the changing CRE landscape, it’s important to consider how your portfolio may be impacted by the changes (and how you should respond).
CRE Debt and Capital Market Trends
Inflation is currently at a 40-year high. As we look ahead, it’s anticipated that the feds will raise interest rates by another 100 basis points by the beginning of 2023. For commercial real estate owners and investors, current debt and capital market trends such as increasing rates can present unique challenges for your firm’s debt management strategy.
During the webinar, we discussed three debt and capital market trends in today’s market: floating rate loans versus fixed rate loans, interest rate caps, and the LIBOR to SOFR transition.
Floating Rate Loans Versus Fixed Rate Loans
When deciding between floating and fixed rate loans, there are three factors that should be considered in addition to interest rates:
- Supply and demand
- Local markets
- Current financing structure
By understanding these three factors, you can better determine which type of loans makes the most sense for your business.
Interest Rate Caps
An interest rate cap is a limit on how high an interest rate can rise on variable rate debt. A higher cap rate means that the market judges the property to have more risk, which means that investors need to earn a higher rate of return. For investors, an interest rate cap guarantees investment risks are at a minimum, even in a fluctuating market.
LIBOR to SOFR Transition
The transition from LIBOR to SOFR requires commercial real estate borrowers and lenders to have a thorough understanding of the new index and the potential effects the LIBOR discontinuation may have on their loans or interest rate swaps. The transition from London Interbank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR) has led to major changes in the pricing of global financial products. Although LIBOR will continue to be published until June 30, 2023, banks can no longer issue new LIBOR-based loans as of December 31, 2021.
This transition affects commercial real estate because many CRE loans have LIBOR-based interest rates. For borrowers seeking to hedge risk on floating-rate loans, whether required by lenders or electively, this transition has created complications for loan underwriting.
With LIBOR tied to more than $350 trillion of contracts globally and nearly $200 trillion of US dollar contracts, this is one of the biggest and most significant events in the history of financial markets. And it’s important that your firm is prepared to make this change. To prepare, borrowers should take inventory of their commercial borrowings and determine which loans, if any, have LIBOR-based interest rates. Also, you should begin having conversations with your lender(s) about alternative benchmarks, timelines, and the best path forward.
Optimizing CRE Debt Management with Asset Management Technology
As commercial real estate firms seek opportunities to optimize debt in the coming years, asset management technology is at the forefront of the conversation. Asset management technology, like Lobby CRE, enables you to centralize your loan data, model scenarios, and forecast debt.
Centralize Loan Data
Asset management software centralizes loan data so that borrowers can access all of their information in one central location. With technology, you can review and consolidate financials, documents, and deadlines to better understand your portfolio and optimize your debt management.
Prudent owners and investors typically perform several iterations of proformas, actuals, and the market prior to making a decision. With asset management technology, you can model multiple debt scenarios to help you arrive at a decision more rapidly.
Forecast CRE Debt
Forecasting debt is not always easy. If you have a fixed rate loan, it’s important to understand your loan documents to understand your pre-payment rights and penalties. With asset management software, like Lobby CRE, you can calculate loan and debt assumptions to easily determine which debt options are best for your portfolio.
As the market shifts, a solid debt optimization strategy will be critical for the growth of your portfolio. Watch the webinar, Strategically Optimizing CRE Debt in a Changing Market, to hear the full conversation.