Are the interest rate increases make you change your underwriting

[Marc C.]

Residential interest rates have risen about .5% since the election. Now I've noticed they are up about .25% on commercial/apartment loans as well. http://www.crefcoa.com/apartment-rates-main.html

The strong stock market is attracting investors away from bonds, causing bond rates to rise to compensate. This will continue as long as stocks keep rising. 

Since these rates are based on 6-mo. LIBOR rates, http://www.wsj.com/mdc/public/page/2_3020-libor.ht..., which haven't risen much at all, I'm not sure why the increase in apartment financing rates. Anyone have a theory? 

So, investors, is this affecting your numbers, your analysis, your underwriting? 

It wouldn't take much more of a rise to cause some folks to want to back out of deals and for cap rates to widen. If you were buying a 7 cap with 4% money, will you be looking to retrade into a 7.5% cap if money rises to 4.5%? Seems logical.

It's making me nervous about the two deals I'm working. One is a Master Lease-Option with a 3-year time limit...who knows what rates might be in 3 years? 

[Brian Burke]

@Marc C. you definitely have to adjust your underwriting. Underwriting properly means being honest with yourself. If lending rates are higher you have to underwrite with the higher borrowing cost. It just is what it is. 

Without changing the price, higher borrowing costs would produce a lower leveraged IRR so a lower acquisition price is needed to achieve the same leveraged IRR that you had with the lower rates. By definition this means that the cap rate is higher, but not necessarily in parallel to the higher borrowing rate.

I didn't have to change much, though. I bumped up my acquisition and refinance rate a half-percent. I've already been underwriting to a decompressing cap rate so no change there but I might have to bump up the starting cap slightly. 

In talking with some of the brokers I know they've been seeing some fall-outs. I suspect a few deals where the buyers were playing too close to the fence might fall apart. Some lenders might underwrite to lower proceeds to maintain debt yield or DSCR thresholds and that might catch some buyers off-guard if they can't raise the additional equity or if raising additional equity drops the IRR below marketable levels.

Why are rates moving?  Most fixed deals are tied to the 5, 7 or 10 year UST and those rates are up about half a point.  Floating rate deals are less effected because they tend to index to the 1 month LIBOR which is up around a quarter. 

Fortunately for me I only have one deal exposed...closing escrow next week.  The good news is it's an assumption deal so 90% of the borrowing cost was already locked in. Our supplemental will cost about an extra half point, but it's only 10% of the debt stack so the effect is minimal.