Prepare for Impact
When commercial mortgage rates reset on your property, it can have a significant impact on that property’s ongoing performance. It’s never too early to prepare for the adjustment and plan proactive countermeasures. Commercial mortgage rates are often fixed for a period, typically five to 10 years, after which they reset to a new rate based on prevailing market conditions. Needless to say, the reset can potentially result in a substantial increase in the monthly mortgage payment. This is yet another reason why it’s important to receive sound advice from an experienced team that has the depth of knowledge necessary to help you make sound decisions.
Impact on Cash Flow
A commercial mortgage rate reset affects your holdings in several ways. First and foremost, the increased mortgage payment can clearly put a strain on the cash flow of the property. If the property is generating enough income to cover the new payment it may be able to weather the storm. However, if the property is not generating sufficient income, the increased payment may push it into negative cash flow territory, making it difficult to cover other expenses such as maintenance, taxes and insurance.
Impact on Property Value
Another potential effect of resetting commercial mortgage rates is a decrease in property value. If the property is not generating enough income to cover the new mortgage payment, the property may be forced to sell. The consequences could be a lower sales price, as potential buyers will take into account the increased mortgage payment when making an offer.
Impact on Lenders
The impact of resetting commercial mortgage rates can also be felt by the lenders who hold the mortgages. If a property is forced into default due to the inability to cover the new mortgage payment, the lender may be forced to foreclose on the property. This can create a loss for the lender, as the property might be sold for less than the outstanding mortgage balance. Lenders with less than $250 billion in assets (think SVB) play an outsize role in the economy, accounting for 80 percent of commercial real estate lending and 45 percent of consumer lending. Small and midsize banks are expected to slow lending drastically in an effort to strengthen their balance sheets after the crisis. The pullback is likely to result in a quarter- to a half-percentage-point drag on G.D.P.
There are several strategies that property owners and lenders can employ to soften the impact of resetting commercial mortgage rates. One approach is to refinance the mortgage before the reset date. This allows the property owner to lock in a new rate, ideally lower than the reset rate, before the reset occurs. This is effective, but refinancing may not be an option if the property is not generating enough income, or if the owner has a poor credit history.
Another strategy is to renegotiate the current mortgage terms with the lender. This could include extending the loan term, reducing the interest rate, or both. This approach is more likely to succeed if the property owner has a good relationship with the lender and is able to demonstrate a track record of generating income from the property.
A third strategy is to sell the property before the reset date. This can be a viable option if the property has appreciated in value and can be sold for a profit. The downside of this approach is that selling a property can be a time-consuming process, and there is no guarantee that the property will sell for the desired price—or how quickly.
Bottom Line: Be Proactive
The resetting of a commercial mortgage rate is an unfortunate reality that has a significant impact on the ability of a property to remain performing. Property owners and lenders must be proactive in mitigating the impact by employing strategies such as refinancing, renegotiating mortgage terms or selling the property. By taking a proactive approach, owners and lenders can minimize the impact of resetting commercial mortgage rates and ensure the continued success of these properties.
For more information about, contact M1 Capital today!