When it comes to financing commercial properties with variable rate loans, lenders often require borrowers to hedge the risk of rising interest rates. This can be done with the purchase of interest rate caps, through which borrowers will receive a payment whenever benchmark rates rise above a certain level. This protection typically lasts for 3 years but can extend up to 5 years, and it reassures lenders that borrowers will be able to make payments on their debt.
Many of the hedges purchased during the pandemic are still protecting borrowers from the recent spike in rates, but they will expire in the next year or so – and they will be much more expensive when it comes time to buy again. One estimate puts the current cost of a 3 year cap at 3% at about $3.5 million. The same cap cost just $98,000 in April 2019! Unless rates drop significantly before current hedges expire, the cost of extending the hedges will be prohibitive for many. For landlords who are unable to refinance to a fixed rate loan, or who don’t have the ability to inject equity to keep their loan above water, it might be time to sell.