Interest Rate Cap Fees Are Crushing Transactions

How many ways can a CRE borrower say out? How about a good factor of ten when it comes to interest caps on adjustable-rate commercial real estate loans?

“In the last 18 days, I had about a billion dollars of real estate I was trying to buy,” Grant Cardone, CEO of Cardone Capital, tells GlobeSt.com. “We were doing a deal with $300 million worth of debt, AAA asset, AAA location, everything lenders would want. What we would normally pay $500,000 for was $12 million.” The deals were done … done in, that is.

It’s not the current size of interest rates, but the anticipation of what they Federal Reserve has said it would do over the next 12 to 18 months that has lenders racing for protection. And the more protection a borrower wants in a 12-to-24-month window, the more it’s going to cost.

“We had somebody who had an interest rate cap, but when they signed the deal two months ago to when they could get the deal closed recently, the price tripled,” Thompson Coburn partner Josh Mogin says. “They had to take $1.2 million to buy a cap they were planning to spend $300,000 to $500,000.”

It’s taken a lot out of the momentum that commercial and multifamily lending saw in the first quarter. Originations had increased 72% year over year, according to the Mortgage Bankers Association. The group did say that increases in interest rates “take some wind out of the sails of borrowing in upcoming quarters,” although “strong market fundamentals, property values and investor interest should continue to support the market.”

Then again, maybe they were a bit optimistic, at least when it comes to borrowers looking for short-term flexible financing.

Uncertainty has driven many potential sources for the credit swaps needed for interest rate caps to seek safer pastures. “The other side of that transaction, you need someone who has the exposure and is willing to take that,” says Brian Richardson, CFO of regional bank Univest. “We priced a couple of caps recently for folks that were interested, but in every case, they said, ‘No, that’s too expensive for me. One example was on the two-year side of two to three points of protection, you were paying 50 to 75 basis points on the loan.” That was a significant chunk of the entire rate, and all due up front as a fee.

Borrowers are having to make hard choices. Meg Epstein, CEO of CA South, a real estate development and investment management firm in Nashville, hasn’t gone the cap route because she thinks rates won’t be up for that long. “I could easily say cap rates were compression for so long that I could sell a building for a 4% cap and now it’s probably a 5,” she tells GlobeSt.com. “All that’s causing us to do is be more conservative in our underwriting for the person who’s going to buy my building.”

Mogin thinks that some borrowers at least will benefit from the flood of capital that’s entered CRE lending. “People are coming up with somewhat creative ways to figure out how to continue to operate in this market and spread some of the risk of increased interest rates.” But those solutions aren’t cheap for the borrower and could become a problem for those that took short-term 3% bridge loans. “There are some that are definitely going to have trouble getting out. Not every project is going to turn out to be a winner.”