As the Yield Curve Steepens: Fixed vs Floating Rate

[Spencer Gray]

I've always been a big believer in long term, fixed rate debt - and I still am. What's better than eliminating interest rate risk on a deal for 5, 10, 12, or 35 years in the case of a HUD 223(f)?

That being said, as the yield curve steepens, variable based rates indexed to shorter maturity notes have the potential to stay much lower for quite some time with the Fed having more influence on these than longer term notes. Fixed rate debt, which is typically indexed off the the 10 year treasury, that has risen significantly the last few months, nearing back to pre-pandemic levels. While lenders can adjust their spreads to keep actual borrowing rates competitive for a while, eventually real borrowing rates will rise as well. 

This is a different environment than the past few years when the spread between the shorter and longer term bonds was very tight, even inverted. That is no longer is the case.

I still think locking in historically low fixed rate debt is a no-brainer in this environment, but am curious if others are using, or considering utilizing variable rate debt to take advantage of even lower rates to drive your return?

[Brian Burke]

I totally agree with @Nick B.. It would be very difficult for me to find any reason to use fixed rate debt in a commercial multifamily investment unless I was a legacy holder (like a family office that holds for decades if not generations). 

As a syndication sponsor that typically invests for a 3-7 year investment cycle, yield maintenance risk is far scarier to me than interest rate risk.  I’ve always used floating rate debt and never regretted it. Only one time I bought a deal and assumed existing fixed rate debt, and I really regret it. It’s made that deal enormously difficult and challenged our exit.

But here’s an example of how floating rate has benefitted us:  I bought a deal for $40 million less than two years ago.  I just listed it for sale and we expect to sell for the mid-$60s.  We’ll pay $300K or so to pay off our floater.  If we had a fixed-rate loan it would probably be north of $5 million. We could sell on an assumption, but the price would probably take a hit by roughly the same amount. I’d rather have my investors get the five million than my lenders.  So my question is...how much interest rate movement would I have to see to lose the same $5 million by taking a floater?