Higher for Longer: The Challenges & Opportunities of Interest Rates

Overview

Before I write anything else, I have to get one thing out of the way: I mean, this is a dream scenario for me. After being wrong for 22 years, I’m finally right. I always said we need fixed rate loans because one day rates will go higher.

Seriously, though, we built our business around making sure we would survive when interest rates went against us. That’s why our core portfolio is in very good shape. We have very few loan maturities, very little floating rate debt exposure, and our long-term fixed-rate loans are at 2% to 4%.

Sadly, for people who built their business around maximizing near term profits, this could be a wipeout event.

Higher interest rates are not all bad, though, depending on which side of the coin you’re on. Banks are just not competitive when you compare it to the higher risk-free rate you can get from the federal government.

But that creates massive ripple effects. Banks are getting squeezed by depositors and borrowers. Their customers are fleeing to no-risk investments that pay a better rate, plus their cost of funding is up. Banks thought they were smart to avoid interest rate risk by offering floating rates to borrowers, but now suddenly they have credit risk associated with those loans.

Here’s the problem: Asset values are going to deteriorate some in the coming quarters. Worse, there needs to be a cash injection into a lot of deals to roll a loan into new financing with that same bank or a different lender.

Higher interest rates are also bad for development. Between the cost of construction and the cost of capital, deals are not penciling. It’s a double whammy: Not only have the returns on equity investments been compressed, but you’re benchmarking against cash earning good returns in high yield savings or money market accounts.

Development deals are going to be dead for a while. That’s bad for our business and bad for everyone. But since we have largely operated in a “land-light” position, we’re not really imperiled by that.

On the positive side, there are opportunities. We’re in the business of solving complex problems. We can help solve those problems for people either by acquiring their assets or having them do a 721 exchange into some of the vehicles we manage. We can bail them out and get them into a larger diversified pool, or we can provide them with some capital to fill a hole in their capital stack.

Every economic scenario offers an opportunity for problem solvers.