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Proactive refinancing in a time of rising interest rates

By Jessi Maness
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When Nashville, Tennessee-based real estate investment and management firm Freeman Webb Company, AMO®, realized in mid-2022 that the Federal Reserve was intent on increasing interest rates, the company proactively refinanced a 16-property portfolio with existing debt that wasn’t scheduled to mature for another 18 months.

The new low-leveraged financing totaled $207 million and was secured by a portfolio valued at $510 million. With the low loan-to-value ratio (LTV) of 40% for the portfolio, the company was able to lock in a favorable fixed interest rate while returning capital to investors and funding capital improvements, which in turn will benefit their residents.

Matt Olson, Freeman Webb Company, AMO®

“At the end of the day, we had debt that was going to mature in the next 18 months,” said Matt Olson, Freeman Webb Company’s vice president of acquisitions and asset management. “We anticipated that interest rates would be higher and values likely lower closer to the loans’ maturities. Contrary to some pundits, we believed that a significant increase in interest rates would invariably result in declining values due to an increase in cap rates, regardless of the strength of the multifamily market fundamentals. Therefore, we chose to proactively refinance this portfolio to take the interest rate risk off the table and return significant capital to our investors.”

Freeman Webb Company is one of many real estate investment companies working on refinances or seeking additional options in this rate-increasing market. This proactive approach requires recognizing market developments as they happen—sometimes even before. While this can be difficult, it’s worth grasping these macroeconomic issues to best serve clients and investors.

The impacts of rising interest rates on value

The macroeconomic context of rising interest rates has changed the investor’s real estate market in multiple ways. According to Olson, there are two main ways the market is impacted. First, new loan proceeds are reduced due to higher interest rates and monthly debt service. This can present the risk of being unable to refinance an existing loan, which in turn requires an owner to either sell the property to pay off maturing debt or invest additional equity to refinance. Second, as interest rates increase, the cost of capital increases and investors’ return expectations change, resulting in increasing cap rates. The cap rate is a ratio of the property’s cash flow to value; therefore, values decline.

Justin Nelson, Walker & Dunlop

Justin Nelson, a senior managing director with commercial real estate finance firm Walker & Dunlop, worked with Freeman Webb Company to secure their refinancing.

He notices two impacts. “Values are regressing about 10% to 20% from their peaks, given short-term rates.” The second impact: “The transaction market has slowed significantly.” He says this is “driven primarily by institutional investment managers essentially resetting underwriting standards, and that’s prevented transactions from driving returns necessary at this point for their various funds and mandates.”

Adam Randall, Newmark’s Multifamily Capital Markets group

Adam Randall, vice chairman with Newmark’s Multifamily Capital Markets group, says there’s a “disconnect” between cap rates and interest rates. “It’s hard to make the return you’re looking for without an extreme amount of rent growth or some sort of event that would make the net operating income (NOI) grow an extraordinary amount.”

When refinancing is advisable

According to Olson, there are instances where refinancing is specifically advisable. “If you have debt maturing in the next 12 to 18 months in a rising interest rate market, and you believe rates will continue to rise and be elevated for an extended period, then you’re better off refinancing in advance of your existing maturity. Refinancing is also advisable if you have floating rate debt. As interest rates rise, your cost of capital increases monthly, and you would benefit from proactively refinancing to fixed-rate debt.”

Randall adds, “A lot of debt taken on in the past three to five years has been floating rate, with typical two- to five-year terms, requiring borrowers to buy an interest rate cap. For so long, interest rate caps were very inexpensive, but over the last year or so, the cost has gone up significantly—probably 100 times what they previously were.” This means that if someone paid $17,000 for a cap two years ago, now that cap costs $1.7 million. “And because the borrower is not expecting the costs to be that high, some are being forced to refinance, if they can, into a fixed-rate loan because they don’t want to have the cost burden of an interest rate cap.”

Management and being proactive with financing

Stephen Farnsworth, Walker
& Dunlop

Stephen Farnsworth is the senior managing director for real estate finance with Walker & Dunlop and worked closely with Freeman Webb on their 2022 refinance.

“Many—though not all—sponsors of multiple properties tend to look at their maturity list and their portfolio leverage to make sure they’re staggering things well and keeping a good balance of overall capitalization.

They’re managing their mortgages to ensure they’re not lumping them all up to have similar maturity dates. They want to have a good balance—and get ahead of it—by evaluating their options well before their maturity year,” Farnsworth says.

Being proactive and not waiting to see where rates are 12 to 24 months down the road has helped Freeman Webb mitigate the interest rate risk for their investors. Others who were hoping for rates to come down have run into the scenario of being unable to refinance out of their existing loans—which, in some cases, has forced them to sell the asset or contribute additional capital to the property in order to refinance.

Details of a proactive refi

Farnsworth explains what was unique about the Freeman Webb transaction, as an example, was that the market had slowed in the latter half of 2022, and capital stopped flowing. “The rising rates caused a lot of debt funds to hit the sidelines in addition to banks who were already on pause,” says Farnsworth, “and then life companies really couldn’t underwrite their credit parameters to get the appropriate leverage. But the agencies, Freddie Mac and Fannie Mae, remained active, especially for strong sponsors like Freeman Webb and properties with an affordability element that ties to their ‘mission’ housing goals.”

He goes on to say that Freeman Webb was astute in recognizing those market dynamics and knew they were sitting on a portfolio of attractive mission housing that would align with the agency goals. “They took advantage of the market to get very good credit terms.”

Real estate managers can help clients by tracking macroeconomic conditions and recognizing potential refinancing opportunities. Proactive financing can deliver wins across the board, from the property’s investors, who enjoy stronger returns, to its residents, who benefit from the improvements possible from freed-up capital.

Note: Rates in this article are as of its writing.

What’s going on in multifamily financing?
Stephen Farnsworth, Walker & Dunlop
“The agencies remain active and willing to lend to multifamily owners who can ‘check the boxes.’”

Justin Nelson, Walker & Dunlop
“I think the landscape is good. There’s a lot of demand for lenders to still put out mortgages. But the alternative investment realm—take corporate bonds, for instance—with rates as high as they are, leaves it challenging. There’s not as much deal flow that can be accommodated where rates are at right now. I’ve talked with at least 25 different real estate owners, and the overarching theme that people believe, at least in the relatively near-term, [is that] the next year or two will see rates coming down. I certainly think financing volume will be down in 2023—just because of the rate environment. There will be a lot less voluntary refinancing if folks have terms on their existing loans with good rates.”

Adam Randall, Newmark Multifamily Capital Markets
“In 2022, the first part of the year was very active but came to a halt when rates began to rise. Now, some deals are being done but not as much volume as there has been historically. I think 2023 will be a down year compared to 2022—and especially when compared to 2021.”

Journal of Property Management

Jessi Maness is a freelance writer and the editor of Celebrate Nashville, a publication established in 2013 that honors and celebrates different facets of history in Nashville and the whole of Tennessee.

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