On today’s show we are talking about what is up or down with interest rates.
Interest rates are traditionally influenced by two main factors, inflation and risk. If inflation goes up, then naturally investors will want their bonds to at least keep pace with inflation. If the investment is perceived to have higher risk, then investors will want a premium to compensate them for the higher risk. These are the two principles at work in pricing interest rates.
But of course there isn’t a single interest rate. There are short term rates and long term rates. The short term rates will often experience larger swings than the long term rates. Shorter loans tend to be linked to short term interest rates like libor. Longer permanent financings tend to be linked to the yield on the 10 year government treasury bill.
In recent weeks, the yield on the 10 year treasury has fallen to the lowest level in two years. The US dollar has remained persistently strong as the uncertainty over global trade has sent investors globally looking for safety. The vehicle of choice seems to be US treasury bills. That explains why the yield for 10 year T-bills is falling.
But since long term mortgage rates are tied to the 10 year treasury, mortgage rates have fallen to below 4% on the longer 30-35 year loans.
So what does this all mean for real estate investors?
I believe that the period of low interest rates is here for a while longer. That means that prices for commercial properties will broadly remain stable. Even an modest economic downturn will not have a dramatic negative impact on prices for commercial multi-family properties.
If you’re considering a bit of profit taking, or rebalancing your debt to equity ratios, now might be the perfect time to do that.
You may have one more year remaining on a conventional loan. Locking in for another 5-10 years at today’s rates would make a lot of sense even if you had to pay a 1% pre-payment penalty. Often times, if there is only one year remaining on a loan, the bank may waive the pre-payment penalty if you refinance with the same bank. They would rather keep the business and waiving the pre-payment penalty might be the necessary inducement to stay with your present bank. But even if you elect to pay the penalty, remember that you’re going to amortize that penalty over 5 or seven years, so a 1% penalty has roughly the same cost as a 0.2% increase in the interest rate over 5 years. If you can save more than 0.2% in the interest rate by refinancing, it would be worth paying the pre-payment penalty. Many people refinance in order to increase a loan amount, or reduce it. As long as you can maintain a responsible debt coverage ratio, you might consider increasing your loan amounts and pulling some equity to build up a war chest of cash to prepare for new acquisitions in the coming years. There is still a lot of money sitting on the sidelines and while there aren’t too many bargains in the market today, there will be a time when bargains will re-appear.
