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The choice between a fixed interest-rate loan and a variable interest-rate loan is often made using a simple rule of thumb: A fixed-rate loan is better when interest rates are rising; a variable-rate loan is best when rates are falling.

 

Multifamily Investment Property Financing: Should I Choose a Fixed or Variable Rate?

Mar 07, 2019

When you arrange multifamily investment property financing, you are agreeing to loan conditions likely formed on the basis of current options, which you do not have full control over, and on projections for your financial future and the development of the economy. All these factors involve a high level of uncertainty. This uncertainty may seem like a risky mix going into such a crucial decision, but, with care, you can find the best financing option for your needs.

Choosing the Type of Loan for Multifamily Investment Property Financing

The choice between a fixed interest-rate loan and a variable interest-rate loan is often made using a simple rule of thumb: A fixed-rate loan is better when interest rates are rising—so your rate does not rise too—and a variable-rate loan is best when rates are falling—so your rate falls too. While this rule captures the overarching principle behind the decision, it ignores many of the finer points of each option.

Both types of loan have relative advantages, regardless of rate trends. A fixed-rate loan makes it easier to project the cost of servicing the loan, as the interest rate is locked in for the long term. This reduced volatility translates into lower interest rate risk. Variable-rate loans are characterized by lower starting rates and greater flexibility for prepayment. While interest rate risk is higher with variable-rate loans, many lenders require the borrower to purchase an interest-rate cap, which is a derivative product that pays the buyer an amount at the end of each period when the interest rate exceeds an agreed upon strike price. These interest-rate caps reduce the risk of large increases in interest rate.

If you have a fixed-rate loan, you may not be able to take advantage of lower rates in the future, because it will likely be more costly (perhaps prohibitively so) for you to refinance it due to its high prepayment penalty. A prepayment penalty is known as yield maintenance when it is set at a level to provide the lender with the same yield it would receive if the loan were carried to term (adjusted for the time value of money).

Those factors will make it harder to sell the asset, too, if the loan is assumed rather than refinanced. Thus, while a variable-rate loan will have more risk from rate volatility, it may be easier to sell the asset, because the transaction itself will be less costly. This is more likely to occur when interest rates are falling, of course.

Regardless, the likelihood of accurately predicting future interest rates is limited, which illustrates the importance of accurately projecting your financial needs. The choice between a fixed- and variable-rate loan may not always be based on just interest rates. If you are acquiring a multifamily property for repositioning, for example, your strategy may call for a comparatively fast exit date. In that case, you might care more about marketabilty of your investment than optimizing the interest rate. Your choice of loan type based on that criterion might look completely illogical to a buyer with a longer sales horizon.

The other investments in your portfolio must be considered too. High servicing costs on a loan may offset gains elsewhere for tax purposes, and this could be a sound strategy for a number of years, if the high-interest asset promises an attractive gain as well.

Getting the Multifamily Investment Property Financing You Need

Commercial mortgages are products that are offered in the market. Lenders know what loan conditions the market can bear, but they are competing for your business. So, you should shop for the right loan to be as successful as possible. If you have a clear strategy in your business plan that requires specific loan conditions, you may be able to negotiate for them. This requires careful thought, a deep understanding of finance and economics, and serious negotiating skills.

At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and multifamily real estate valuation to transaction support and property management. We specialize in assisting our clients with 1031 exchangesacquisitionsrepositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country and employ a team of experts who can help you hone your investment strategy.

For more articles like this one, check out our investment strategy blog posts.

Please contact us to learn more about investing with CWS Capital Partners, or view our current offerings by completing our self-certification form for accredited or qualified investors.

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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.

All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.

Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.

Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.

 


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