Why So Negative? Q3 Interest Rates
We are halfway through Summer and in between all the negative news of labor strikes, travel delays, and increased consumer prices, you may have heard that interest rates are up from last year’s all-time lows… the U.S. 10-year Treasury (US10Y) closed last week at 2.67% up from 1.24% this time last year.
Inflation, rebounding, Federal Reserve hawkishness, volatility—sure you’ve heard it all before and none of it is earth-shatteringly new at this point. Even the biggest and baddest REITs aren’t immune.
I’m over here thinking about negative leverage a lot these days because we’re talking about it so much with our clients, and I’m wondering if this time the tenor is different.
Here are the reasons someone might take a commercial real estate loan:
- Replace debt in a 1031 exchange without spending more cash.
- Buy more property than with cash alone.
- Buy better property than with cash alone.
- Pull tax-free cash out of an illiquid investment.
- Increase return on every dollar borrowed. Not right now!
Note that what all of these have in common is the CASH component. Put another way, considering whether to use leverage or use cash is often just an exercise in opportunity cost. What would it “cost” me if I didn’t buy this bigger property? What would it “cost” me if I could instead invest my cash elsewhere instead of all locked away on this property? What would it “cost” me to pay increased capital gains taxes this year? What might it “cost” me if I could only do a smaller amount of depreciation? All of these (and many more) are valid considerations when investing in commercial real estate.
Periods of short-term negative leverage have occurred in the past, and from time to time they occur even in highly liquid markets on some specific investments, but even I’ll admit that a sustained outlook of interest rates higher than cap rates/returns is definitely unique, if that’s indeed what we are seeing.
I’m a borrower too, and am not thrilled with my borrowing costs going up either, but I’m thinking about it a little bigger picture…
Personally, I think inflation at today’s metrics makes all the difference; potential for tax savings, borrowing today and paying it back with cheaper future dollars, an opportunity cost of nearly 10% in eroded purchasing power for my cash to stay on the sidelines, getting into more leases with rental increases to shield my cashflow, etc. These are all reasons why I might still want to be an active investor and be willing to pay a pretty penny for the privilege, even with some negative leverage.
I’m wondering out loud if the elimination of that 5th reason (that I may not make money on borrowing someone else’s) isn’t all that important in the grand scheme of things, even if it ends up with a market with sustained bid-ask-spread issues.
For what it’s worth, we’re still slammed with requests…
What are your thoughts? We would love to hear from you.