With the prime rate at 7.5% at the start of 2023, even the “best” interest rates in commercial may not be worth locking into a permanent loan. When rates have been historically low – as in the range of 4% for the last decade – it may be unwise to settle for paying this year’s rates for the next 20 years. However, there are options to still invest in your future without sacrificing your leverage. These are the top tactics that we recommend for tackling high interest rates in 2023.
TOP TACTIC #1: Use a Bridge Loan
In the current market, even the “best” rate may not be worth locking into a permanent loan. When rates have been historically low, (as in the range of four percent per the last decade,) it may be unwise to settle for this year’s low of six percent. However, there are options to still invest in your portfolio’s future without sacrificing your leverage.
One of the strongest options available is the Bridge Loan, otherwise known as interim financing, gap financing, or swing loans. The bridge loan is best used for commercial real estate acquisition, tenant improvements and construction. The terms shorter than the conventional, typically around 12-24 months – but longer terms can be made available, if required.
Bridge Loan Payoffs
Once the note matures, the bridge loan is likely to pay off in two ways:
1.) Hopefully, the enhancements or construction will have stabilized the property and enhanced the market value (by strengthening the collateral, increasing number of stable tenants, etc.)
2.) The recent spike in long-term rates will hopefully already resolved itself – as cycles have historically resolved within 18 – 36 months
For comparison, the events leading up to the most recent mortgage meltdown of 2008 were eerily similar to recent events: interest rates were rising, we were in a “seller’s market”, pricing pressure was climbing, and demand persisted while rates rose – before the crash occurred. Using that pattern as a possible prediction of what’s to come, we can suspect that the rates are likely to lower in the next 12 to 18 months – thus employing a bridge-to-permanent loan may be one of the most ideal financing tactics available.
Bridge Loan vs. Conventional Loan: A Cost Comparison per $1M Borrowed
Bridge loan terms are typically 12-18 months, and priced at around two to three percent (2%-3%) above the average conventional rate for similar property types. Assuming the bridge loan is interest-only (I.O.) at 10% – you could expect a monthly debt service payment of:
$1,000,000 x 10%/12months = $8,333 monthly
In comparison, amortizing conventional loan terms are typically 20 years, so on the same $1,000,000, at today’s prime rate (the average of major bank rates surveyed) of 7.5% today. Assuming this is a loan with a 20% initial down payment, a monthly principal and interest (P&I) payment on a 20-year loan would be $8,056 monthly. (Calculation made using an amortization calculator.)
As you can see, the difference in actual debt service is nominal.
TOP TACTIC #2: Use a Hybrid ARM
The second of the tactics that we use to hedge against the short swings of high interest rates is to use a hybrid adjustable-rate mortgage, or Hybrid ARM (also known as a “fixed-period ARM”).
These loans are a hybrid of a fixed rate mortgage and an adjustable-rate mortgage, with interest rates that reset in three, five, seven or nine years (though we prefer the three- or five-year options in this climate).
The initial rate is based on an index plus a margin, with the index being any publicly quoted index – such as SOFR, Prime or U.S. Treasury notes – plus a margin or percentage rate like “+ two percent (2%)”. The loan resets one time, using the exact same-sourced index and margining as originated. Thus, the chances of getting better start rate savings and avoiding locking in at higher temporary rates (or paying the expenses to refinance in the next 3-5 years when rates cool off) are much better.
Of course, each commercial loan deal is unique and tactics should be chosen carefully to make sure that they align with the future that you envision for your business or portfolio. Before employing either of these winning tactics, be sure to consult with a commercial loan expert, like the team at Commercial Capital Ltd., FL. They offer a free consultation to look over your business or portfolio and help you to strategize for your best intended outcome. To learn more about Commercial Capital Ltd., FL, visit their website or check out their glowing Google reviews.