The Cost of Borrowing

Federal interest rates have resided at historically low levels since the beginning of The Great Recession, with the US 10 Year Treasury Rates dipping as low as 1.50% in June of 2012 (see Figure 1).

Figure 1

Figure 1

The Federal Reserve’s Quantitative Easing (QE) program has continued to keep rates low and provided a necessary kick-start to the economy, allowing lenders to cautiously re-enter the market. Established borrowers were able to take advantage of these low interest rates by refinancing a large portion of their portfolios and achieving historically low costs of capital.

With a recovering economy and tapering Quantitative Easing in 2013, interest rates spiked to levels nearing 3.0% (see Figure 2). Economists expected interest rates to continue to rise in 2014. However, instead of rising in 2014, rates exhibited extreme volatility due to many macroeconomic issues, namely Europe’s recession and worldwide unrest over ISIS, Ebola and Vladimir Putin. In addition, lender sentiment towards the US real estate market improved steadily, increasing the supply of funds. With 2015 upon us, the US 10 Year Treasury has settled around 2.25%.

Figure 2

Figure 2

The question then remains, when will rates rise and by how much? Three factors will determine rates and their increases heading into 2015: (1) FED activity, (2) the macro economy, and (3) lender sentiment.

(1) With Janet Yellen at the helm, the FED is likely to keep the federal funds rate and US Treasuries as low as possible. Still, more tapering in QE and an emphasis on increasing inflation will exert upward pressure on treasuries. 2.25% is an unsustainable rate for the US Treasury, so expect rates to rise quickly from this rate, though not to levels above 3.0%.

(2) The global outlook remains grim for much of 2015. The macro economy remains in tatters, following the European debt crisis and political sanctions against Russia taking effect. While India and China continue rampant growth, the rest of the world is dealing with high cost of capital, oil price fluctuations, and threats of default. Southern Europe’s debt crisis has reached rock bottom, with nowhere to go but up, but a quick recovery is out of reach. Even Germany, the strongest nation in Europe, expects a decrease in trade surplus, a reflection of Europe’s instability. International equities will see continued volatility, pushing lenders to seek the safety of US Treasuries.

(3) CRE Lender Sentiment was positive in 2014, evidenced by easing underwriting standards and a growing pool of satisfactory borrowers. According to a recent survey by Friedman Research, that appetite is expected to continue, keeping the market flooded with money… leading to cheaper money.

It is only a matter of time before treasuries return to “normal” levels between 4%-5%, which will cause much higher mortgage rates. However, there is little evidence that rates will rise substantially in the near future. Instead, borrowers will benefit from aggressive lenders and the suffering world economy, capturing low rates before 2016 arrives.

By William Burke, Analyst, Largo Real Estate Advisors, Inc.; wburke@largocapital.com

The Largo Group of Companies is a commercial mortgage banking firm that structures, closes and services commercial mortgages for acquisitions, refinances and redevelopment projects. Largo arranges innovative commercial real estate financing structures for borrowers throughout the United States and Canada. We manage the loan process from loan application through closing and service the loan throughout its term.

Largo has 17 correspondent relationships and offers additional lending sources, providing property owners and developers long-term, non-recourse commercial real estate financing at a competitive fixed rate.