Reprinted from New York Real Estate Journal - July 16, 2002 |
Low Interest Rates
Continue to Fuel the Real Estate Market
GCP Capital Group specializes in arranging financing packages for the income producing real estate investor. This includes standard first mortgage loan financing as well as structured levels of participating debt and equity often referred to as "Mezzanine Financing". All investors approach a particular acquisition with a certain return on investment in mind. Some may achieve that return through cash flow from operations while others may require a capital event such as refinancing or sale to achieve the required rate of return. Either way, the cost of debt and/or equity is always considered when analyzing a potential investment. Obviously, the cheaper the cost of borrowing, the greater the return, or as in the market we are experiencing today, the cheaper the cost of borrowing, the more a borrower is willing to pay for a property. In today's real estate investment world, we see valuations and asking prices far above what we saw just several years ago. Investors today are willing to risk capital and contribute time and energy to their investments for less of a return then they would have accepted a short time ago and the cost of capital has played a dominant roll in sustaining and increasing value. Low interest rates may increase an investment's potential return and they may also help to increase the amount of loan proceeds available. Most lenders have debt coverage ratio requirements that average 1.2 times. This means that for every dollar of required debt service, the property must generate $1.20 of net operating income. So, as debt service decreases, loan proceeds can potentially increase as a result of being able to respect the minimum debt coverage ratio. So what drives interest rates and where are they going? Well, I've been asked that question a million times by clients trying to "time" the market, and my standard answer is that if I truly knew which way rates would move, I'd probably be trading bonds on my laptop from my 130 foot yacht somewhere in the Atlantic. The truth is, no one really knows. Our global economy is so sensitive to world events that today's volatile political issues make it impossible to predict. I do observe a number of factors that I feel will contribute to a sustained atmosphere of low rates. Investor confidence in the equity markets is shattered. Traditional stock investors have done poorly over the last couple of years and with the current fiasco of accounting irregularities, even more confidence has been lost. These investors are likely to seek safer havens by purchasing government debt, which will drive down the yield on these instruments. Secondly, the U.S. economy is doing well but not as good as once thought. Inflationary pressure is in check and the Federal Reserve seems to be doing a good job in regulating the money supply. Thirdly, I feel that the political unrest throughout the world and the underlying fear of future terrorist attacks on U.S. soil will prompt the American public to be more cautious with their spare cash and therefore willing to accept lower yields on bank deposits. Lastly, and probably most importantly, we have an abundance of institutional capital available for mortgage loans and this large pool of competitively priced money will help keep interest rates low. Let's keep our fingers crossed. |
This is not only true for the debt instrument (mortgage loan), but
also for the cost of third party investor equity and the opportunity cost of one's own
capital.