Every headline, social media post, and conversation surrounding commercial real estate seems to be centered around one singular topic—the Fed's continued interest rate hikes. A positive perspective is the key to succeeding in anything, especially commercial real estate, but it is impossible to ignore the effects this has, and will continue to have, on all aspects of the industry. It’s not the magnitude of the increases as much as the speed of the increases that has negatively impacted the commercial real estate market. The rapid and pronounced rise has caused an inverse, but equally steep, correction in the number of commercial real estate capital markets transactions as investors process the impact of much more expensive debt capital. Those that are still in the market by choice, or necessity, are being forced to get creative. Otherwise, they risk ending up negatively leveraged if they are not buying all cash. However, assumable financing—once an out of favor capital market solution—has recently found itself very much in vogue as a salve to the impacts felt from higher interest rates.
Assumable debt has not been an in-vogue dynamic of commercial real estate capital markets transactions for a variety of reasons—some more complicated than others. The simplest yet most significant reason is that terms for in-place loans could be bested by new financing available in the marketplace. Prior to the enormous rise in the cost of financing seen in recent months, buyers and borrowers were in no rush to assume loans with either at or above market interest rates. Fast forward to second quarter 2023 and now the shoe is on the other foot, with lenders more reticent to approve loan assumptions with interest rates far better than today’s prevailing market.
The landscape has changed significantly in the last six months, and assumable debt is no different. What was once an unattractive point is now appealing. While the assumption process is not for the faint of heart, the efforts and cost it takes to complete can quite possibly result in underlying financing that is far more favorable than where debt markets have gone today.
Every downturn in market conditions—regardless of the specific industry—tends to manifest some silver linings and opportunities in the tumult. Today assumable financing opportunities represent one such bright spot in a landscape cluttered with disruption. Buyers eager to make acquisitions without the excessive higher cost of financing should look at these opportunities. Sellers with financing in place should consider how the debt can bolster the value of their assets. In many instances, it’s quite conceivable that the implied value of the financing may mean that the property is worth 25 to75 basis points of cap rate better than where the property would be valued without the financing. This value premium could prove quite fleeting. If prevailing Treasuries drop lower as inflation cools, the value associated with assumable financing could quickly vanish.
BJ Feller serves as managing director and senior vice president and Jack Collins as senior associate at Northmarq.