A third interest rate hike this year is widely expected by the end of 2017, with the U.S. economy looking strong despite unusually low inflation. Let’s take a look at the potential effects of continued rate hikes on commercial real estate financing, particularly on multifamily borrowers.
Federal Reserve Chair Janet Yellen speaks in Washington on June 14, 2017. (AP Photo/Susan Walsh)
The 10-year Treasury yield increased 67 basis points in the 15 months from July 2016 to mid-October this year (closing at 2.37 yesterday), in the course of which the overnight rate has increased three times, in December, March and June. If there continue to be more rate hikes, it is possible that longer-term interest rates will rise as well.
Rising interest rates often signal a healthy economy (assuming that inflation is stable), which usually bodes well for the real estate industry. But markets can be a bit of a “mystery” even to economists, to use Federal Reserve Chair Janet Yellen’s characterization of the fall in inflation earlier this year. (For more on the connection between interest rates and commercial real estate, here’s a primer.)
If interest rates continue to rise and lenders sense the need to protect themselves against a potential decrease in property value, they could eventually tighten lending standards further and require more equity from borrowers as they seek to increase their loan-to-value ratios.
This is of particular concern for multifamily borrowers. That’s in part because the share of U.S. banks reporting tightening standards for multifamily loans began rising sharply in early 2016, according to the Federal Reserve’s senior loan officer survey, which tracks the activity reported by about 60 large U.S. banks and two dozen U.S. divisions of foreign banks
Lenders can tighten lending standards in a variety of ways, such as requiring more equity or collateral from the borrower, limiting lending for borrowers deemed less creditworthy and reducing exposure to riskier properties, markets or types of financing (such as construction lending vs. refinancing).
That increase in tightening standards reported by U.S. banks was sharper for multifamily loans than for construction and land development loans, though the trajectory is similar. Though reports of tighter standards continue to be up over 2015, the rise has become less steep over the last few quarters – yet the effects of the tightened standards can only be seen in the lending after a delay allowing the lending practices to take effect.
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