Choosing the right lender with rates coming down… finally!
As we come into spring and the days get longer and the skies brighter, and… we have finally seen rates come down and settle at new levels, we are now seeing a widening of lending options. While that’s great news, it also presents the challenge of deciding the best program when financing a piece of commercial real estate. It’s a great problem to have, but requires more thoughtfulness than a year ago when we were just happy to find one option, much less 3 or 4. What are some of the variables to consider when making that program decision? Below we’ll discuss several.
First, you need consider how long the loan is fixed. We’ve seen in the past borrowers jump at a 10-year option when rates had dropped and couldn’t go lower. As we all saw from 2017-2021, if you had locked your rate back in 2015, you would have missed out on the rate drops we saw in those years to come. In this era now, we will still likely see some additional softening in rates over the coming 3-4 years making a 10-year fixed a mistake as the prepayment penalty will likely preclude the benefit of any additional reductions. There is an additional consideration which is related to your portfolio. Many times – even when rates were low – we would have clients be thinking longer term fixed when there was no evidence on their real estate schedule of ever keeping a loan that long. That’s not surprising given that the average commercial loan is in place for 5-6 years. While longer term might indeed be the right option for a given scenario, you should also consider other options as well.
Second, you need to take into account features of the program such as an interest only period. In that case, the question is whether the interest lonely benefit will improve cash flow enough to justify the higher interest rate. This is increasingly becoming a consideration as we see differences in interest rates between lenders. As an example, lender A might offer 3 years of interest only but at a rate ½% higher than lender B without any interest only. But the actual payment difference could be minimal if any making lender B the more attractive alternative. Another example could be an old issue in CRE lending of recourse versus non-recourse. Using the similar situation as above where lender A offers non-recourse lending, while lender B does not, but is significantly lower in rate, as a borrower you need to consider the relative risk of recourse (which is only a possibility of ever coming into play) versus the actual tangible benefit of a better rate and cash flow.
The last issue we see arising more and more now is the impact on loan proceeds from the combination of debt coverage requirement and interest rate. We have seen a number of examples in the past several months where a lender with a lower interest rate but requiring a higher debt coverage actually in the end offered more loan proceeds. That is simply a function of the lower rate overriding the higher debt coverage. We have concluded the zero effect difference in interest rate is approximately .35%. A larger gap points to the lower interest rate with the higher DCR while a smaller gap in rates generally favored the lower DCR.
In the end, most lenders don’t discuss these kinds of issues with borrowers. That’s precisely where the benefit of commercial mortgage brokers – whether CLG or anyone else – allows for a much broader array of solutions. As brokers, we know one size does not fill all. The bank can only offer what they have without giving any suggestions if they cannot meet the need. This issue is becoming more pronounced now with the widening gap in programs and rates! Even with the numerous variables to consider now, at least they come at a time when rates have drifted lower and begun to stabilize. Perhaps the CRE lending engine is about to finally rev back to life!
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