3 Reasons to Refinance Your Multifamily Property NowPaul Winterowd
Debt is an integral part of real estate for most investors. There are a myriad of different strategies and schools of thought regarding debt and real estate. The purpose of this post is not to offer ideas on which approach is best, but to simply to offer 3 compelling considerations as to why it makes sense to take a hard look at your existing debt on your commercial multifamily real estate.
1. Interest Rates are Still Low, But on The Rise
We have been enjoying the fruits of a very favorable interest rate environment for the last 5 years or so. The 10-yr. Treasury, which most commercial real estate debt is based on, plummeted to the 2% range in the middle of 2011 and has basically stayed in that 2-3% range ever since. There have even been a couple periods below 2. 10-year term loans in the 3-4% range have become the new normal in many ways.
I don’t have a crystal ball revealing where rates are headed, but one thing we know for certain is that change is constant. We know rates will eventually move and logic tells us a move downward is rather unlikely. As one of my good friends says, “you can’t fall from the floor…”
The Federal Reserve has telegraphed a couple additional federal funds rate hikes in 2017 and they’d certainly like to systematically get that rate up to a point where they would actually have the ability to lower rates to stimulate the economy should they need to.
Given the likelihood of rates increasing, investors who lock in these low rates now for the next 10 years, or even better yet with a 35-year fixed rate HUD loan, are putting themselves in an advantageous position to garner higher cash flows from their properties because of the lower payments the low interest rates produce.
2. Leapfrog Forced Balloon Payment in Next Market Downturn
We know that markets have cycles, and real estate is no different. We are currently in a very nice spot in the real estate cycle, especially for multifamily. Dividend Capital Research’s quarterly summary of where we are in the real estate market cycles is called the “Cycle Monitor”. It pegs most major U.S. markets in Phase 3 (“Hypersupply”) of the four-phase cycle.
We have navigated through the “Recovery” and “Expansion” phases, but the one on the horizon is the rather unpopular phase called “Recession”. We know this is coming, we don’t know when though. It could be next week – highly unlikely – or it could be three years from now, or even five. I do remain optimistic about our future; however, it is rather unwise to forget about the hard times.
We as humans tend to put on rose-colored glasses when things are good and tend to ignore that prosperity won’t last forever. Tougher times will ensue and there are two things no multifamily investor wants to face in those downturns – a forced refinance and no cash to take advantage of opportunity.
More on the lack of cash in a moment. Facing refinance risk in recessionary periods can be particularly problematic. Depending on the severity of the recession, borrowing money becomes exponentially more difficult than it is today. Lenders become afraid and suspend their capital offerings, thus causing borrowers to clamor for the financing they need. Many banks really scale back lending in these periods which makes the terms far less favorable for borrowers, if they can even get any terms at all.
Right now (spring of 2017), there is plenty of money available for borrowers. Safe to say it’s a borrowers (buyers) market currently. As a borrower, it makes sense to take advantage of this favorable climate. In periods of Recession however, it becomes a seller’s market for debt, and the lenders hold all the power. This means far less capital is available, terms are less favorable, and interest rates command premiums.
The point of all this is – now is the time to lock in as much long term debt as you can to leapfrog the forthcoming difficult times. The last thing you want as an investor who has put millions of dollars into a property is to be forced into a balloon payment (refi situation) during periods of economic difficulties because the chances of losing that property are significantly increased if you can’t satisfy that balloon.
3. Values are Peaking, Maximize Cash Out
Despite large amounts of new development in the multifamily space over the last few years, there remains a shortage of apartment housing in many markets across the country. Occupancy remains robust and other than in you’re A-class properties in major cities, rent growth still outpaces historical norms.
It is a good time to be an owner of multifamily real estate which means current owners are reluctant to sell, and a lot of people want to get in the game. When demand outpaces supply, prices go up and in the case of multifamily real estate cap rates go down. Declining cap rates equate to higher property values. Higher values coupled with amortizing debt creates equity.
Equity is a great thing to have, but untapped equity can be incredibly expensive. My undergraduate degree was in economics and I was fascinated by the concept of “opportunity costs” when I was first introduced to it. Investopedia defines an opportunity cost as “a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity costs represents an alternative given up when a decision is made.”
Wow! When multifamily investors make the decision to leave their equity untapped, there are a host of foregone opportunities. The one foremost in my mind is the opportunity to acquire additional multifamily assets. I can’t determine for you what the ideal use of that equity is, but I do know you can achieve a far greater ROI on that equity when it is extracted and leveraged on another multifamily asset.
An even more prudent strategy would be to extract that equity and keep the cash on hand. We need not look further than billionaire Warren Buffett to learn a very simple wealth building strategy. Buy when everyone is selling and sell when everyone is buying. Buffet has built up huge cash reserves, money sitting on the sidelines, waiting for that perfect opportunity. That opportunity usually comes in difficult times when cash is scarce. He buys and rides that wave up to create massive amounts of wealth.
Could there be a smarter thing to do at the peak of a cycle than to pull cash out of your properties, put it on the sidelines, and wait for that fantastic opportunity?!? Not likely. It certainly requires a lot of patience and discipline, but will yield huge dividends for the few that follow this advice over time. It sure did for Warren Buffett.
Now is a great time to refinance your multifamily property because rates are low, property values are high, and turning equity into cash opens up new investment opportunities for you.