Oct 17, 2023 7 Min read
Commercial real estate investment can be a lucrative venture, but it comes with its fair share of financial risks, including fluctuating interest rates. To navigate these uncertainties and protect their investments, savvy commercial real estate investors turn to financial tools like interest rate caps. In this blog, we'll explore what interest rate caps are, how they function, and why they offer substantial benefits to commercial real estate investors.
Interest rate caps are financial instruments or agreements used to mitigate the risk associated with variable interest rates on loans. They work as a form of insurance, capping the maximum interest rate a borrower will have to pay, even if market interest rates rise beyond that threshold.
Interest rate caps are best understood through an example:
Imagine you're a commercial real estate investor who has taken out a loan with a variable interest rate. The initial rate is attractive, say 5%, but you're concerned about the potential for interest rates to rise, which could significantly impact your loan payments.
To protect yourself, you enter into an interest rate cap agreement with a financial institution. You specify a cap rate, which is the highest interest rate you're willing to pay. Let's say you set the cap rate at 7%.
As the loan term progresses, market interest rates fluctuate. If they rise above your cap rate, your interest rate cap provider steps in. They will make payments to you, covering the difference between your actual interest rate and the cap rate. This ensures that your interest costs remain within the 5% to 7% range, even if market rates spike to 8% or higher.
Now, let's dive into how interest rate caps benefit commercial real estate investors:
Interest rate caps serve as an asset for commercial real estate investors. While interest rate caps are tied to the original loan, many do not know that if they were to refinance, that interest rate cap holds value. In some cases in 2023, we have seen the valuations of some of these interest rate caps in the hundreds of thousands of dollars upon refinancing, offering a significant benefit to investors. Therefore, if you are not factoring interest rate caps into your calculations of a refinance, you can be losing out on an opportunity to get a deal done right now.
Interest rate caps are invaluable tools for commercial real estate investors seeking stability and predictability in their financial strategies. These instruments provide protection against the potential adverse effects of rising interest rates, allowing investors to make more informed decisions, manage risk, and ultimately enhance their investment returns.
In a dynamic market where change is the only constant, interest rate caps are the anchor that can keep commercial real estate investors on course. At Terrydale Capital, we can help you navigate the ever-shifting tides of interest rates with confidence and achieve financial success in your commercial real estate endeavors. Contact us today.
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