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Multifamily Finance Blog

Last updated on Jun 30, 2023

11 min read

by Jeff Hamann

Assessing Your Need for a Multifamily Refi in 2023

Even though interest rates are higher than they've been in a good long while, there are many signs that point to further hikes. Learn if a refinance could be the right move for your apartment complex.

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In the multifamily investment sphere, staying abreast of real estate financing's shifting dynamics is essential. This year and last have brought about some seismic shifts that impact borrowers and lenders alike.

This guide provides critical insights and guidance for those considering refinancing or managing loans approaching maturity amidst these changes.

Grasping the Current Reality of Refinancing

Refinancing in 2023 is a journey through a labyrinth of economic fluctuations, significantly shaped by the Federal Reserve's persistent increase of the federal funds rate that started early last year. These changes have far-reaching implications, influencing sectors across the economic spectrum, with a particular impact on real estate financing.

Understanding these new dynamics is crucial. When the federal funds rate increases, it results in a tightening of monetary policy. This tightening leads to a reduction in the money supply in the economy and an increase in the cost of borrowing. Consequently, the yields on government bonds, corporate bonds, and other types of debt also rise. As multifamily loans are often pegged to these yields, this directly affects the rates at which these loans are offered.

The Ripple Effect of Federal Funds Rate on Multifamily Borrowers

The federal funds rate serves as a cornerstone for various financial activities, and any fluctuations cause a ripple effect that reverberates through the entire financial ecosystem. While multifamily loans may not be directly tied to the federal funds rate, they often correspond to other indicators such as the 10-Year Treasury and SOFR, or the secured overnight financing rate.

When the Federal Reserve raises the federal funds rate, it triggers a domino effect that ultimately impacts these indicators. For example, when the cost of borrowing rises, investors demand higher yields on government securities, pushing the rates of 10-Year Treasury notes higher. The SOFR, which represents the cost of borrowing cash overnight collateralized by Treasury securities, also usually increases in response to a federal funds rate hike.

For multifamily investors, this cascade means higher interest rates on adjustable-rate loans and a higher cost for new loans or refinancing. The precise impact depends on the specific terms of their loan agreements, including factors like the choice of reference rate, loan term, and whether the interest rate is fixed or adjustable. Therefore, understanding these intricacies and monitoring the evolving financial landscape becomes paramount in making informed refinancing decisions.

Understanding the Current Interest Rate Landscape

In the context of multifamily financing, understanding the current interest rate landscape is akin to understanding the weather conditions before setting sail on a voyage. The dynamics of interest rates set the stage for the decisions you'll make about loan management and refinancing. Let's delve deeper into the indicators that play significant roles in shaping this landscape.

Federal Funds Rate and Its Influence on Interest Rates

The federal funds rate is not merely a figure announced by the Federal Reserve — it's a powerful tool for controlling inflation and maintaining economic stability. This rate represents the cost that banks charge each other for overnight loans, and it serves as a baseline for many other interest rates.

When the Federal Reserve anticipates inflation or an overheating economy, they increase the federal funds rate, which generally results in a rise in interest rates across the board. These decisions are made during the Federal Open Market Committee (FOMC) meetings, which occur eight times a year.

While the impact of a federal funds rate increase on adjustable-rate loans may seem straightforward — as the rates on these loans can fluctuate over time — it's equally important to understand its effect on fixed-rate loans. The interest rates for fixed-rate loans are set at the time of loan origination and remain unchanged over the life of the loan. If a fixed-rate loan is originated during a period of rising interest rates, the borrower could lock in a higher rate for the entire loan term. Therefore, awareness of the federal funds rate and its trajectory is vital, regardless of the type of loan.

Role of 10-Year Treasury and SOFR in Multifamily Loan Rates

While the federal funds rate can give us a general direction of interest rate movements, the 10-Year Treasury yield and the SOFR provide more specific indicators that directly influence multifamily loan rates.

The yield on 10-Year Treasury notes is a key benchmark for long-term interest rates, including fixed-rate multifamily loans. A rising federal funds rate often leads to higher yields on these notes, which translates into higher interest rates for new loans.

The SOFR, on the other hand, is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. It's often used as a benchmark for adjustable-rate multifamily loans. Just like the federal funds rate, a rise in SOFR results in increased borrowing costs.

Current Interest Rates

It’s easy to see how keeping a close eye on these indicators, along with the federal funds rate, can provide a comprehensive picture of the multifamily financing landscape. See the table below for today’s rates.

Predictions on Future Interest Rates

Forecasts and predictions on interest rates can be complex, impacted by a range of economic factors. Currently, based on ongoing economic trends and Federal Reserve actions, the consensus is that interest rates are more likely to continue their upward movement in the near term. Analysts have projected one or two more rate hikes by the end of 2023.

However, the financial world is marked by uncertainty, and forecasts are not set in stone. Economic indicators, geopolitical events, and even unexpected crises can cause rapid shifts in these predictions, and the Fed's response can alter accordingly.

Therefore, timing becomes an essential element for those considering refinancing. While no one can perfectly time the market, understanding these trends and predictions can offer critical insights and help multifamily borrowers make informed decisions.

The Case for Refinancing Now

In the current climate of rising interest rates, deciding when to refinance can feel like a high-stakes game of chess. Making the right move at the right time is key. Let's explore why refinancing now could be a smart strategy.

Why Refinancing Now Might Be the Best Option

Given the trend of escalating interest rates, refinancing sooner rather than later could potentially save multifamily borrowers substantial amounts over the life of the loan. It's true: The rate you'll receive on a new loan will likely be higher than the one on your existing loan, especially if it were originated a few years ago. But the crucial point here is that it could be significantly lower than the rate you'd get if you waited too long and rates got pushed higher.

To calculate the difference, start by determining the total interest cost of your current loan for the remaining term. Next, calculate the total interest cost of a potential new loan. Then, compare the two figures. This can give you a ballpark estimate of the potential savings or additional costs involved.

Cash-Out Refinance: What It Is and How It Works

A cash-out refinance can be a powerful tool for multifamily investors. It involves refinancing your existing loan for a larger amount and taking the difference in cash, effectively allowing you to tap into your property's equity.

Suppose you have an existing loan balance of $500,000 on a property valued at $1 million. With a cash-out refinance, you could potentially get a new loan of $750,000 (assuming a 75% loan-to-value ratio), pay off the existing $500,000 loan, and walk away with $250,000 in cash. This cash could then be deployed towards renovation work, other investment opportunities, or even as a buffer for future contingencies.

Evaluating the Cost of Refinancing

Refinancing comes with a price tag. It's essential to understand the costs involved, particularly prepayment penalties, to make a well-informed decision.

Prepayment Penalties and How They Work

When you refinance, you effectively pay off your existing loan with a new one. If this happens before the end of the loan term, you may incur a prepayment penalty. These penalties vary widely and depend on the type of loan and its terms.

Common types of prepayment penalties are listed below.

Step-Down

This is a declining penalty that reduces over time. For instance, it could start at 3% of the outstanding loan balance in the first year and then reduce by 1% each year.

Defeasance

Here, the borrower provides the lender with a portfolio of Treasury securities. The cash flow from these securities compensates the lender for the loss of interest payments due to early repayment. This is generally an extremely complicated process that requires legal experts.

Yield Maintenance

This penalty ensures the lender receives the same yield as if the borrower had made all scheduled mortgage payments until maturity.

Others

It's important to note that some loans also have lockout periods during which no prepayment is allowed. You likely will be unable to refinance until the lockout period has ended.

Comparing the Cost of Prepayment Penalties vs. Higher Interest Rates

Comparing potential prepayment penalties against higher interest costs due to rising rates is a balancing act.

To begin, you'll need to understand the prepayment penalty terms of your existing loan. These can be found in your loan agreement or by contacting your lender. Calculate the amount this penalty would be if you were to refinance today.

Next, estimate the potential increase in interest cost if you were to refinance in the future. This would involve predicting future interest rates — a complex task that would require analyzing current economic trends and possibly seeking advice from financial advisors. Calculate the difference in interest over the life of the loan between your current rate and this estimated future rate.

By comparing the prepayment penalty with the increased interest payments, you can make a more informed decision about when to refinance. But remember, these are just estimates. The financial world is inherently uncertain, and your calculations are only as good as your assumptions. Nevertheless, they provide a valuable starting point and can help guide your refinancing strategy.

Making an Informed Decision

The decision to refinance involves more than just comparing interest rates and prepayment penalties, it's also an introspective process of examining your financial goals and the strength of the asset in question.

Factors to Consider When Choosing to Refinance

While the current and projected interest rates, potential prepayment penalties are crucial to consider, these external factors only form part of the picture. Your specific financial goals are an equally significant piece of the puzzle. Are you looking for short-term liquidity, long-term stability, or growth capital for further investments? The right time to refinance should align with these goals.

Additionally, the strength of the multifamily asset you're considering refinancing is pivotal. A strong asset typically has consistent occupancy, positive rent growth, and potential for further value to be added. These attributes make your asset more attractive to lenders, which may result in better loan terms. Conversely, if your asset is in a market with weak population or economic growth, lenders may perceive it as higher risk, impacting your ability to secure desirable refinancing terms.

Best Practices for Multifamily Borrowers

The multifamily financing landscape is complex and continuously evolving. Being informed about the interest rate environment, understanding the implications of various loan indicators, and accurately evaluating refinancing costs are all crucial steps on the path to a sound refinancing decision.

However, there's one more thing: Never underestimate the power of shopping around. Lenders' appetites for multifamily loans can change drastically due to a variety of factors. This means that the lender who gave you a great deal on your last refinance might not be the best choice this time around.

Reaching out to multiple lenders, including credit unions, banks, debt funds, and REITs, can give you a better perspective on the available loan options and help you secure the best deal. And that's exactly what our form does at the bottom of this site — it gives you the ability to get your deal in front of thousands of lenders with a few clicks.

So don't wait: Get started on your journey to a more profitable refi today.

Final Thoughts on Refinancing in 2023

As we find ourselves in the throes of rising interest rates, the decision to refinance now or hold off becomes more pressing. But, remember, the best decision hinges on your financial goals, the strength of your multifamily asset, and a meticulous comparison of costs — including potential prepayment penalties and future interest costs.

While these decisions aren't easy, they are fundamental to steering your multifamily investments towards continued growth. With the guidance offered in this article, combined with your unique insights into your assets and goals, you are better prepared to face the financial tides of 2023 and beyond.

As a final step, don't forget to take full advantage of our platform. By entering your details, you get your deal in front of potentially thousands of lenders, vastly improving your chances of securing a deal that aligns with your investment goals.

It's time to harness the power of informed decision making. Don't wait for the tides to turn — steer your course now.