Whats the best way to calculate returns with a variable rate?

Question

I’m looking at a commercial loan for a tri-plex, and I want to know what’s the best way to calculate returns when your mortgage rate is a variable rate?

Bobby Larsen · Answer

@Clay Cook

Google Chatham Financial and get on their mailer.  They email an updated yield curve for LIBOR and SOFR every Monday.  No guarantee that rates follow those projections but if I was able to predict rates more accurately that the yield curve, I’d be a bond trader.  Use the yield curve to adjust your projected interest rate throughout your hold period.

Evan Polaski · Answer

@Clay Cook, as Justin noted, there is no right or wrong answer, since variable is just that and no one has a crystal ball.

You clearly know your spread and current benchmark rate, so you have an idea of where the rate will be for the next few months.  Given that we are historically low rates, I would model in your cash flow projections that the benchmark rate will be rising steadily over the life of the project/term:  https://www.macrotrends.net/14...

Between 2015 and 2019, 1mo Libor rose from .15% to 2.4%.  If you think we are going to see that same growth, that would mean about 40-50bps per year. I would call the pretty conservative and realistic.  If the deal makes sense at these numbers, I would be happy. And of course, if rates stay low, you end up with more cash flow.

Clay Cook · Answer

Account Closed That sounds like a really helpful resource. Thanks for passing that along.

Spencer Gray · Answer

@Clay Cook I would ask if there is a floor/ceiling for the rate. There often is or you ask for a ceiling or "buy" a ceiling so you know what your max rate exposure is. I would then stress test your deal using the ceiling rate. For your "baseline" model you could use the mean of the floor and ceiling or the mean of the current rate and the ceiling.

Clay Cook · Answer

@Evan Polaski

Thanks so much for your input, and particularly your reference to what's a ballpark number for where interest rates may go.

Justin Goodin · Answer

That’s a good question. Not totally sure 🤷🏻‍♂️  Try using a conservative rate or just look into getting a fixed rate option.

Whats the best way to calculate returns with a variable rate?

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