10yr #Multifamily Investment Loan Rate Comes Back to Life, Rises 7.9 Basis Points

The 10 year apartment building investment loan rate we track moved up to 4.454% from 4.375% yesterday after flatlining at the old rate since the middle of January:

10 year treasury vs. apartment building investment loan rate May 2015

Even so it is still below what we used to think of as the 4.5% floor for this rate. Meanwhile the ULI rate has been tracking the 10yr Treasury, rising from 3.37% April 20th to 3.76% yesterday, a climb of almost 40 basis points.

Is this the beginning of the long anticipated (The 3rd or 4th year in a row that everyone’s known rates were going to rise) rate hikes? It makes sense that the Fed would like them to get up off the floor if for no other reason that they would have room to lower them again when they needed to. But is now the time to do that when China, Europe and the rest of the world are slowing down?

While the US economy has been mostly improving, Q1 2015 numbers once the final revisions are made a couple quarters from now might maybe still show a positive number but don’t be shocked if it turns out to have dipped. Yes, bad weather (at least back East) and port strike in LA were temporary constraints on growth but the rising dollar and falling oil prices are hurting companies connected to energy and those who export or do business in foreign countries are hurting on a continuing basis. And while the top level unemployment number has been shrinking it’s been doing it on the back of pretty flat wages, still too many working part-time involuntarily and a shrinking labor pool. And then there’s this from a Deutsche Bank report on Bloomberg the other day [Emphasis mine]:

“Since 1948, the Fed has increased its benchmark on 118 occasions against a quarterly backdrop in which the average growth in nominal GDP was an average 8.6 percent, Deutsche Bank’s strategists wrote in a report published Wednesday.

Only in the third quarters of 1958 and 1982 did the Fed shift when nominal growth was undershooting 4.5 percent and the latter action was even reversed a month later.

So for virtually every rate increase since Harry S. Truman was in the White House, nominal GDP was growing 4.5 percent or faster, with 112 occurring when it was above 5.5 percent.

That may give Yellen pause, according to Deutsche Bank. Since the recovery began in the middle of 2010, nominal GDP growth has averaged 3.9 percent in a range between 3.3 percent and 4.7 percent. For the first quarter growth was at 3.9 percent and is now likely lower because of the trade data.

While Reid and Nicol accept it could spike between now and September, it would still require quite a rebound in activity to deliver 4.5 percent.

In their eyes, the risk is that if the Fed still raises rates when nominal GDP is so weak the central bank may come to regret it. Minneapolis Fed President Narayana Kocherlakota is already calling a hike this year “inappropriate.”

“There is no template in history for assessing the likely consequences of raising rates when growth is this low, asset prices are generally this high and with debt still so large,” said Reid and Nicol. “To be safe we’d like to see nominal GDP consistently get to at least a 5-handle before rates rise.”

But there’s more. The big picture macro issue is that the Fed and our government are turning Japanese. Japan’s lost decade or Ushinawareta Nijūnen began after the collapse of their real estate and stock market bubbles in 1989/1990 which means it’s old enough to be graduating with a master’s degree this year. Unfortunately for us our government and the Fed are following the exact same game plan of protecting the banks and helping them to hide their insolvency at the expense of the economy, especially down at the Main St. level.  If you want to have déjà vu all over again read the Wikipedia page Lost Decade (Japan). For a deeper look see the NBER report: The Causes of Japan’s “Lost Decade”: The Role of Household Consumption. And then there was that Vapor’s song from the ’80s

About the spread between the T10 and the apartment building rate we track, the green line on the chart represents the six months trailing average spread. We track changes in the trend for signs apartment lenders becoming more or less competitive. Note that since rates are only quoted on business days the chart averages the last 120 business days which roughly equates to six calendar months.

We track the 10 year Treasury (T10) because that is the benchmark most lenders base their long term rates on. In order to lure investors away from Treasuries to buy mortgage bonds lenders have to offer a premium (AKA ‘spread’) over what can be earned on the ‘risk free’ Treasury. So when the T10 moves, rates on all kinds of longer term loans including on apartments tend to move also. As you can see in the chart, the spread also widens and narrows as market forces make an impact.

Notes about the apartment loan rates shown in the chart above: The rates shown here are from one West Coast regional lender for loans on existing apartment buildings between $2.5 – 5.0M. The rate quote they send every Monday that I track is a 30 year amortizing loan with a fixed rate for 10 years (They also have other fixed periods at different rates). The max LTV for this loan is 75% (they have an even lower rate on their max 60LTV loans) and the minimum Debt Cover Ratio (DCR, aka DSR or DSCR) is 120. Note too that these are ‘sticker’ rates, LTVs and DCRs and ‘your millage may vary’ depending on how their underwriting develops.  I usually figure that we’ll end up at a 70LTV which also helps the debt cover and provides a larger margin of safety, which is half the battle from a value investing standpoint.

The prepay fee is 5,4,3,2,1% for early repayment in the first five years and you do have the ability to get a 90 day rate lock. The minimum loan is $500k (at a slightly higher rate for less than $1M loans) and they’re pretty good to work with as long as you go in knowing that it takes up to 60 days to close their loan. If you are looking at acquiring an apartment building in California, Oregon or Washington I’d be happy to recommend you to my guy there for a quote. Send me a message through this link and I’ll make an introduction for you.

The other rate we track is the from the Trepp survey which the ULI (Urban Land Institute) reports on. According to the ULI the Trepp rate is what large institutional borrowers could expect to pay on a 10 year fixed rate, less than 60% LTV loan for a “crème de la crème” core property located in a gateway market. We track this rate as a barometer of what the largest lenders are offering their best customers on the most secure loans for any advanced warning about future rate changes. Note that the spread we chart is between 10yr loan we track and the T10.

How the St. Louis Fed calculates the 10 year Treasury rate displayed above: “Treasury Yield Curve Rates. These rates are commonly referred to as “Constant Maturity Treasury” rates, or CMTs. Yields are interpolated by the Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. These market yields are calculated from composites of quotations obtained by the Federal Reserve Bank of New York. The yield values are read from the yield curve at fixed maturities, currently 1, 3 and 6 months and 1, 2, 3, 5, 7, 10, 20, and 30 years. This method provides a yield for a 10 year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity. For even more detail see: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/yieldmethod.aspx

As a reminder, one basis point or 1bp is equal to one-one hundredth of one percent or .0001. When you hear ‘fifty basis points’ that’s one-half of one percent; ‘125bp’ would be 1.25% or a percent and a quarter, sometimes referred to as ‘a point and a quarter’. A bp seems like a tiny number, too fine to make a difference but in the debt world if you can squeak out an extra 20bp on a 100 million dollar deal (like a pool of apartment building loans) that’s $200,000.00 in your pocket. To paraphrase Everett Dirksen: 20bp here, 20bp there and pretty soon you’re talking about real money. If you did that every week for a year that would be $10,000,000 and you’d still have two weeks for vacation!

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