Rate Caps Explained: The New Nightmare for Landlords

Yo fellow young professionals, it's Chad here with some news that might affect us in the commercial real estate game. So you know how property owners have been able to protect themselves against rising interest rates with these things called interest-rate caps? Well, turns out that insurance ain't cheap anymore. Like, it's gone from being a few bucks to costing as much as a gym membership (I'm joking it costs a ton more than that). And it's not just a few deals, it's a third of all commercial property debt that's affected by this. Basically, it's a margin call on the real-estate industry. Some landlords might rather just get rid of their building than spend an astronomical sum on a new rate cap. The other option is to refinance into a fixed-rate loan, but more on that later.

What are interest rate caps, you ask?

I got you. So a commercial real estate rate cap is basically like insurance for your mortgage. It's a derivatives contract that limits a borrower's exposure to rising interest rates, in other words, it helps protect you from the increase in borrowing costs. It's like a safety net, so when interest rates go up, you don't have to worry about your mortgage payments skyrocketing. It's kind of like how you insure your car, but instead of insuring against accidents, you're insuring against interest rate hikes. It's usually required by lenders when you're taking out a floating rate loan, which is a loan where the interest rate changes based on market conditions. So, it's a way to protect your investment and make sure it doesn't get hit too hard by unexpected rate hikes.

What does this mean for Investors?

So, when it comes to protecting your commercial property from rising interest rates, you've got a few options, one of them is to buy an interest rate cap, like I explained earlier. Another option is to refinance your loan at a fixed rate, and the last one is to sell the property.

Sometimes, buying an interest rate cap might not be a cost-effective option for property owners. If the cost of renewing the rate cap is too high, it might make more sense for the property owner to sell the property instead. For example, if the cost of renewing the rate cap is so high that it would wipe out a year's worth of rental income, the property owner might decide that it's better to sell the property and invest the proceeds in something else.