Newark, NJ – The 10-year US Treasury yield, a major interest rate benchmark, rose by more than 80 basis points over the first three months of 2021. That’s a fairly big swing, enough that the finance community is listening closely to the Federal Reserve about whether they’ll change their policy approach to stem inflation worries. The market was pleased to hear from the Q1 Federal Reserve minutes that, no, they are working to keep interest rates low for now.
Real estate investors care about market interest rate benchmarks for multiple reasons, but not least of which is that they generally affect the borrowing costs of money for their investments. So the key question here for investors: if these benchmark rates are on the move upward, how has that affected commercial mortgage rates?
Balance sheet loan rates
When it comes to banks and credit unions lending from their balance sheet, there are two interesting takeaways:
- There’s weak correlation between the rise in Treasuries and the average commercial mortgage rate quoted. Commercial mortgage offers, broadly speaking, are not higher rate, which is interesting.
- The lowest rates in the sub-3% range have all but disappeared this past month. The lowest rates have regressed toward the mean, as shown by the below chart with a lower interest rate variance between banks and credit union quotes.
Why haven’t commercial mortgage rates moved in step with Treasuries?
One important fact to consider is that when interest rates are at or near historic lows, lenders more often quote fixed rate loans at a spread over an index floor, rather than the actual benchmark index. So when Treasuries were providing a yield of less than 1%, many lenders would use 1% flat as a replacement benchmark. This means that as Treasuries rise, commercial mortgage rates won’t rise in tandem until that index clears the artificial index floor. The 5-year US Treasury Yield has yet to clear 1% barrier, for instance.
Another factor moderating commercial mortgage rates is that banks and private debt funds are sitting on a large amount of “dry powder”. They need to make loans to make a return on that capital, both through fees and interest, so the excess money supply keeps rates low.
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