Rising interest rates have hurt real estate companies in a number of ways, some less obvious than others. One of those is the cost of hedging against rate jumps for firms with variable-rate loans.
The cost of some of those derivatives, which function as interest-rate caps, has jumped by a factor of 10, according to a report by the Wall Street Journal.
Some companies are looking for alternatives, such as fixed-rate debt.
“Cheap financing is no longer a market reality for companies,” Helen Kane, director of risk and exposure management at Hedge Trackers, a software provider, told the publication.
Interest-rate caps are contracts that firms buy to protect themselves from sharp increases in rate benchmarks, which can send the cost of their variable debt — aka debt with adjustable interest rates — soaring.
Borrowers are often required to buy these derivatives from their lenders, who want to be assured that spiking rates don’t force their customers to default on their loans. When companies protect their debt with a cap, they receive a payment when an interest rate benchmark rises past a certain threshold.
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Prices for caps have surged this year as the U.S. central bank has raised rates. For a three-year, $100 million interest-rate cap tied to the Secured Overnight Financing Rate, prices averaged $2.2 million in October, up from $200,000 a year earlier and $45,000 two years ago, according to figures provided to the Journal by Riverside Risk Advisors, a hedge advisory firm.
Variable debt costs less over time and can be paid back early without penalty, which is why commercial property owners usually prefer it, Amol Dhargalkar, managing partner at risk advisory firm Chatham Financial told the newspaper.
Some companies have sought to extend their loans to manage rising costs. Developers are also seeking leniency by requesting higher threshold rates, to reduce the likelihood that the cap will be triggered.