“If something cannot go on forever, it will stop.”
– Herbert Stein’s Law

Confession time (besides not being an economist), I will be turning 48 this month and will mark my 30th year in the professional work force. I have been around the block a couple times and have been through my share of credit cycles. However, I am hard pressed to remember one that is playing out exactly as this one is doing. Real rates (rates adjusted for inflation) are negative which historically has been bullish for risk assets. Yet risk premiums continue to blow out with “risk-on” the mantra of the day. This is a new one for me and for everyone my age or younger (important perspective on decision makers.)

For the sake of brevity lets ignore why it’s happening and instead focus on what actions we may want to consider taking (regarding CRE financing strategy.) Last newsletter I discussed borrowing fixed rate if you are predicting stagflation (or for stabilized legacy assets where you never want to play the interest rate or cash out refi game.) However, if you believe that we will instead head into recession than floating may be the better option in several scenarios.

Historically, when an inversion preceded a recession (not always) there was an average 1.6-year gap in between. This means the upward pressure on rents in certain asset classes (think multifamily) will continue at least for a bit longer. If you are acquiring (at market adjusted cap rates) value add deals or developing you are better of going floating due to a lack of amortization, flexibility of exit strategy, and lower current pricing. If you really want to hedge outrages rates you can buy a cap far out of the money to avoid a dooms day scenario. Further, if you believe the real yield curve is inverted (I don’t) then you can bank on getting lower rates 3 years out (average recession lasts 1.5 year.) Final food for thought. CMBS and CLO lenders are struggling today as bond buyers find it easy to do nothing or need to be seduced with yield. Banks and some private lenders with A-note or warehouse leverage are still providing very attractively priced financing options (especially for multifamily or BTR development). Leverage is a bit lower but at least the liquidity is still there in the mezzanine loan and preferred equity market to make up the gap.

– David Eyzenberg (Adjunct Professor at NYU Schack Institute of Real Estate & University of Miami Herbert Business School)