Managing Interest Rate Risk

[Greg L.]

Nearly all of my rentals are financed with commercial loans that balloon in 7 years. I have a very good interest rate of 4.75% and with a 25 year amortization. All of these loans will balloon around the same time as I just recently refinanced two of the buildings and will be closing on another one later in the month. I've generally purchased properties that had the potential to generate additional NOI and I've managed them such that I've forced quite a bit of equity, however, my main focus is cash flow. My concern is what level interest rates may be at 7 years from now and the best way I can manage that risk. My thought is just to pay down the mortgages as much as I can. Commercial loans are a fact of life if you play in this space. How are you guys managing interest rate risk associated with them? Also, how much do you think interest rates will rise? It seems to me that there's a hard limit on how far they can rise without tanking the entire economy given the level of public and private debt as well as the impact on financial markets. I realize that the Fed doesn't control all of that however.

[Roy N.]

@Greg L.

Good ideas from both Joe and Omar.   Here in Canada, both commercial and residential mortgage have terms less than 10yrs ... the most common being 5-years, so "balloons" and renewals are the norm.

As Omar indicated your primary concern should be running your business as efficiently as you can and maximizing the revenue stream.    If you have no better use for a potion of your free cash flow, you could focus on paying down your mortgages.    If you go this route, I would focus on a single property - the one which is costing you the most in interest and/or the one which will yield the biggest free cash flow once paid down - until you reach any prepayment limits imposed by your financing terms.

Additionally, if you are able to switch your payments to {accelerated} bi-weekly (26-payments a year) from monthly, that alone will trim your amortization and total cost of borrowing.

Another thing I frequently do is to take-on variable rate financing on a property (which is usually at a lower interest rate than a fixed rate loan ... by as much as a 1 pt), but set my payment as though I have a fixed rate loan. This may not work as well for you as variable rate real estate notes in the U.S.A. are not as attractive as those here (unless there is something other than an ARM which I have yet to encounter).