FLOATING INTO DANGER As costs from interest-rate hikes rise, landlords are feeling the pain

KIRK PINHO

Some commercial landlords are experiencing sticker shock.

Not due to rising interest rates for borrowers — although that plays a role — but instead the cost of renewing what are known as interest-rate caps on some types of commercial real estate loans.

In effect, those derivative con - tracts are insurance policies sold by lenders to borrowers against debt with floating rates which act as a safeguard for borrowers (and lenders, too). When interest rates were lower, those caps were inexpensive hedges against the fluctuating interest on their short-term loans. But today, expect some gasps when hearing the rates for those policies.

Manus Clancy, senior managing director of New York City-based Trepp LLC, which tracks commercial real estate finance and commercial mortgage-backed securities, said borrowers over the last four or five years have been using floating-rate debt to lower their costs or increase their flexibility compared to fixedrate 10-year debt.

Lenders required the cap because they didn’t want borrowers’ debt service coverage ratios, or DSCRs, to drop below a certain level. DSCRs are a metric of cash on hand to pay for debt payments.

In essence, they sought to avoid situations where interest rate increases were “eating into” DSCRs, Clancy said, triggering a default.

— Manus Clancy, senior managing director, Trepp LLC See COSTS