You’ve come to the right place, folks. I’m going to give you exactly what you’ve been asking for. I’m going to tell you what interest rights are going to be tomorrow, a month from now, a year, etc. Just lean in real close, and don’t share this with anybody because it’s really valuable information…
Okay, hopefully you are still reading and are not cursing my name for serving you a heavy dose of sarcasm. With regard to the always-entertaining pastime of predicting interest rates, I must defer to the adage, “If I had a crystal ball, I’d have all the money in the world.” That said, I am a real estate financier and, as such, am frequently asked my opinion on the direction of interest rates. I think it’s hard enough to predict what will happen over the next twelve to twenty-four months and near impossible to predict anything thereafter. But, I will share my opinion regardless.
The U.S. has been stuck in a low-rate environment for years. The Federal Reserve has been pumping massive amounts of money into the financial system with the initial intent to create a floor on asset prices and the ongoing intent to stimulate investment, lending, risk-taking and everything that drives an economy. The approach has more or less worked, but everyone’s great fear is that the chickens will come home to roost, so to speak, and that the U.S. will be subjected to rampant inflation. So far, that has not happened, but the consensus opinion is that interest rates will go up significantly and that it is only a matter of when.
I agree that the overall trend of interest rates over the next five to ten years will be up; however, I do not believe we will see the radical spike in rates that many people fear (or want, depending on your side of the coin). What does that mean in practical terms? Well, the current ten-year U.S. treasury yields 2.45% as of this writing. My bet is that we will be stuck in a very low-rate environment (for numerous reasons that I will not bore you with) for the next twenty-four months or so with any increase in rates not being more than 100 basis points. Thereafter, I think the ten-year U.S. treasury will revert to a level closer to its average over the past twenty years, hovering in the four to six percent range for the subsequent three to five years. Only after this do I foresee the potential for a significant spike in interest rates. Even then, I wouldn’t be willing to bet on it.
I am not a bond trader, so I admittedly don’t have much to lose by being wrong with my prediction. I can, however, point to at least one piece of evidence that justifies my view on interest rates over the next twenty-four months. One of my colleagues at MCA and I recently closed a $10.8mm floating-rate bridge loan for the value-add acquisition of a shopping center in the Dallas area. The lender required that our client purchase an interest rate swap to hedge against any upward movement in interest rates (in this case, LIBOR). Our client was presented with two options: a twenty-four-month swap and a thirty-six-month swap. The twenty-four-month swap was relatively cheap at 30 bps on the loan amount. The thirty-six-month swap, however, was a whopping four times more expensive, at a cost of 120 bps of the loan amount! That pretty much tells you all you need to know in terms of what the bond traders think about interest rates within the next twenty-four months versus rates thirty-six months out or more.
Capital is the lifeblood of real estate, so as a real estate investment banker I understand the need to forecast interest rates and to choose an optimal capital structure for your investment. The easiest advice (one could call it “cheap advice”) that any self-proclaimed investment banker can give is the following: lock in a long-term loan today while interest rates are cheap. But, we all know that every deal is unique, that locking in a long-term loan today may not be an easy option, and that if the real estate business was so easy every real estate investor would be rich and successful.
I can’t predict the future, but I can help you find the best solution today that will help you “hedge” your future… at least with regard to your real estate.