As expected, the start of 2022 has seen the Fed begin to aggressively move overnight funding rates higher, indicative of high market volatility and record-high inflation. Factors unforeseen at the start of the year have further solidified the predicted stream of rate hikes this year. Though there are differing forecasts on how many rate increases are in store for the latter half of 2022, it is clear the market has not reached its peak for the year.
So, how do small multifamily investors make the best long-term decisions in this ever-changing market? Opportunities remain, even in the face of rate increases and an evolving rate environment, for those investors who recognize the value of optionality and who take advantage of rate locking.
The value of optionality
The market has seen elevated volatility in treasury and GSE spreads this year; more than 115 basis points of rate increase since January 1st on 10-year US Treasuries alone. It is difficult to predict where rates will be in the next five years, much less ten to twenty, which is why optionality in debt structures is such a powerful tool in creating long-term value. The fixed-to-float hybrid structure offers certainty of fixed-rate debt for up to 10 years, then a free option to float for the remainder of the 20-year total loan term. It affords borrowers some hedge against unknown future debt markets when it’s time to refinance in 5 to 10 years. If rates are lower at that time, borrowers can opt to refinance their hybrid loan, but if rates are higher, they can hold during the floating rate period.
For example, Freddie Mac Small Balance Loan (SBL) hybrids convert to a 325 bps spread over 6-month SOFR, resetting every six months, with a maximum change of 1% each reset. The floor rate is the interest rate during the initial fixed rate period, and the maximum rate is the floor rate +5%. At a point in time where the Fed is talking about 50 to 75 basis point jumps in overnight rates at every Fed meeting for months, the 1.00% max reset can be an especially valuable feature. It is fairly possible that we could see the market for new debt jump substantially, at which point borrowers with in-place debt at a decent rate for today’s market, would be in a favorable position. Freddie Mac small loan borrowers are in a particularly unique position, as loans are also assumable to a new buyer and existing debt that is of a lower interest rate than a future lending environment can factor into the value of the property to potential buyers.
With the Fed indicating future rate increases, it is likely that rates are only going to increase in the short/medium term, so locking in a 20-year debt term shields a borrower from future volatility.
Take advantage of early rate-hold
As aforementioned, the volatility of the current market is unlike anything we’ve seen in the recent past. The average small loan locked rate over the last 15 months was 3.30%. In January 2021, the 10-year treasury was 0.94% and reached as high as 3.01 so far in May 2022. Freddie Mac has increased their 10-year pricing 85 bps year to date in 2022. With rates shifting daily, the ability to offset rate changes during this time is a significant advantage. Of the small loan products on the market, Freddie Mac SBL allows a borrower to hold pricing upon signature of application, shielding a borrower from rate increases between signed application and closing, which is not the case on most other GSE programs.
Though the lending landscape continues to evolve, the agency small loan executions remain among the best options for small loan investors. As Freddie Mac’s #1 Optigo® Lender and Fannie Mae’s #3 DUS Producer in 2021, our team is well versed in working within their programs to find the best loan executions for clients. Connect with us to learn how we can help you find stability in an uncertain market and secure an ideal rate for your property.
– Josh Bodin, Senior Vice President Securities Trading