A 900% Jump in Hedging Costs Looms Over Commercial Mortgages

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From: https://archive.ph/uQlrw#selection-3309.0-3309.60

As the Fed hikes rates, fees for adjustable loans soar: Like paying for flood insurance as a “hurricane is making landfall” ’ 

The New York City skyline on Thursday, Oct. 21, 2021. 
The New York City skyline on Thursday, Oct. 21, 2021. Photographer: Jeenah Moon/Bloomberg

A fee on US commercial mortgages has surged so high that borrowers can’t ignore it and may not be able to afford it.

Adjustable-rate loans on commercial real estate — including about $350 billion of commercial mortgage-backed securities — almost always require interest-rate caps, a kind of insurance to protect monthly debt payments from soaring out of control when the Federal Reserve boosts rates.

Now that the Fed really is hiking, the cost of that protection has multiplied by 10 this year. For a $25 million mortgage, the cost was $535,000 in early May, compared with just $52,000 in January, for a two-year 2% rate cap, according to Chatham Financial Corp., a hedging advisory firm. Prices for the a similar three-year 2% cap rocketed up as much as 4,000%.

“Last year, it would be like buying flood insurance for your house in the mountains,” ChrisMoore, a managing director at Chatham, said in a telephone interview. “This year, it’s sort of like buying flood insurance for your house on the beach as a hurricane is making landfall.”

The costs are high enough that it may prevent some investors in offices, hotels, malls or apartment buildings from paying for property improvements or potentially even closing a deal. Rate caps are initially paid along with other closing costs, such as commissions and transfer taxes, soaking up about 2% of the principal at today’s prices, said DylanKane, a managing director in the NewYork capital markets group of ColliersInternational.

A borrower with a two-year $25 million loan on an apartment building may have $500,000 less, for example, to buy new windows, flooring or other improvements.

“If you want to close a transaction today, that’s just the cost of doing business,” Kane said. “Nothing in the last three months has shot up quite like this. It’s kind of crazy.’’

The biggest sticker shock may come for borrowers who need to refinance or extend maturities on existing debt. Almost $125 billion of CMBS with with adjustable-rate loans are maturing by the end of 2023, according to data compiled by Bloomberg. More is in the pipeline: About 70% of CMBS and collateralized loan obligations originated this year and last are floating-rate debt, double the share before 2021, according to the CommercialRealEstateFinanceCouncil.

“If a mortgage was taken out two years ago, when rates were very low, the cost of the rate cap was nothing,” LeaOverby, a real estate credit analyst at BarclaysPlc, said in an interview. “Now, it can change a borrower’s decision at an inopportune time.”

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