Interest rate risk hedging

[Wells Mangrum]

For those that invest in commercial real estate with NNN tenants and long leases, what strategies do you use to hedge against interest rate risk?

I believe that the most simple hedge is to obtain a loan that has the same term as the lease.  For example, if the lease is 20 years, it is nice to get a fixed rate loan for 20 years.  This matches the assets and liabilities.  But commercial banks are loathe to write a fixed loan for 20 years, especially in my price range (1-2 million dollars).  

I have heard that life insurance companies give longer term loans.  

Has anyone tried entering into the interest rate swap market as a hedging tool?  It seems like this would be the perfect tool with the one exception that the market is designed for big institutions and not single investors.  I'm particularly interested in interest rate swap futures as these essentially eliminate counter-party risk.  But again, these are not immediately available to individual investors.

[Joel Owens]

Wells the problem is if you are talking about single tenant net lease that market is cap rate compressed. So if you buy a newly minted lease at a 6 cap and went for long range debt to match the primary lease you would be eeking out very little cash flow with cash on cash and generating some principal pay down.

Banks are not giving 20 year fixed rates. 10 is about the best you can hope for and 3 to 7 is more common. A lot depends on how much you are putting down.

What we do to mitigate risk is go out 7 years and see what the rent increases are for total income and what the principal balance left is. One I did the other day the rate could go from 4.5% fixed in 7 years to 7% on the refi and still keep the same cash on cash starting out in year one. You can also analyze a zero break point where you are making no cash flow on the refi. The lender on the DSCR would likely require more down on the refi loan to make the numbers work for the higher interest rate.