We have begun to hear a common theme among commercial real estate clients throughout our market area. As rates and construction prices continue to rise, the viability of some future projects now appears to be in doubt. Depending on the market and asset type, we are hearing that construction cost inflation is running between 5 and 10 percent over the last 18 months. Cap rates have begun to trend upward for most asset classes with the exception of the multifamily sector, which continues to see historically low cap rates. Without a substantial rollback in either interest rates or cap rates, we are likely to see activity in certain markets and asset classes begin to slow by the third and fourth quarter.
We have also heard anecdotes from some brokers advising their clients not to roll 1031 money into new investments, but to rather “just pay the taxes.” That is an indication of the concern clients have about reinvesting their sales proceeds at current price levels. The prevailing strategy for most developers in this new environment is to move from a develop, stabilize, sell model to a more active portfolio management approach. Developers are now assessing what assets they would like to remain on their balance sheets and those they would like to sell. In order to achieve financing on those assets they would like to keep, developers are becoming more willing to accept more conservative loan terms and covenants than in the recent past.
This is a massive shift in the mindset of an industry that has been an enormous driver of the economy throughout the recovery. As developers are positioning their portfolios for the coming period, many are looking to pull refinancings forward to access markets at today’s rates in order to avoid what could be significantly higher costs 18 to 24 months from now.
This shift in the market provides an opportunity for IBERIABANK to guide clients on matching borrowing needs with customized hedging solutions via interest rate derivatives, primarily interest rate swaps. An interest rate swap is an agreement between two parties in which one party agrees to pay a fixed rate of interest and the other agrees to pay a floating rate of interest on an agreed upon notional amount. This vehicle allows banks to protect their balance sheets in a rising interest rate environment as they are able to keep floating rate debt on their books, while clients are able to lock into a fixed rate that reduces the negative impact of rising interest costs on leveraged income-producing assets.
Ultimately, we engage in dialogue with clients to ensure a dynamic approach to hedging that can adjust over time as a client’s needs change and manage the variability of future interest costs.
Antonio (Tony) Rojas is Senior Vice President, Private Banking at IBERIABANK, in the Miami-Dade County office. He is responsible for advising high net worth clients on matters involving risk and asset management, credit structures as well as strategic guidance on other financial instruments and wealth planning solutions.www.iberiabank.com firstname.lastname@example.org