C — November 22 - December 5, 2013 — Shopping Centers — Mid Atlantic Real Estate Journal
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By Marc Snyder, The Real Estate Transactional Group Interest rate swaps: To hedge or not to hedge?
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he definition of Risk: The possibility that some- thing bad will happen.
So what are your options? Many borrowers have sought protection by entering into an interest rate swap to exchange the variable rate of interest for a fixed rate. Without getting into the complexities of such a trans- action, the obvious benefits include more certainty as to monthly payments and pro- tection against rising rates down the road. It sounds like a no-brainer. However, while you may be mitigating one risk, you are taking on additional risks. When you enter into an interest rate swap, there is often a spread between your current rate and the offered fixed rate. For example, your current floating rate may be 3.5%, but the fixed rate offered in a swap transaction may be closer to 5%. Therefore, in order for the swap to work in your favor, the floating rate would have to increase above 5% with enough time left before the maturity date to recover the difference. Borrowers must also con- sider the effects of selling the property that secures
the loan. If the prevailing interest rates at the time of the sale are lower than the fixed rate offered in the swap, the borrower will incur a breakage fee, which may be substantial depending on the size of the loan and the spread in the rates. On the other hand, if you break the swap when interest rates are high, some lenders may credit you with the savings. Interest rate swaps are a great way to hedge against volatile interest rates and provide more certainty for monthly debt service. How- ever, be sure to consider the potential downsides of such a transaction, including the spread between the variable rate of the loan and the fixed rate offered in the swap, the potential for a breakage fee after any prepayment of the loan, and the likelihood that interest rates will rise during the term of the loan. If you’re going to hedge, make sure your trimmers are ready for all possibilities. Marc A. Snyder is an as- sociate at The Real Estate Transactional Group. n
Of course , we all want to minimize r i s k . T h e d e f i n i t i o n o f He d g e : Making an investment t o r e d u c e the risk of
Marc A. Snyder
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adverse price movements in an asset. Sounds easy, right? Wherever possible, hedge your risk. Not so fast. Let’s set the stage. You obtain a mortgage loan that bears interest at a float- ing rate. This creates lit- tle certainty for what your loan payments will be each month. While the property may initially produce enough income to cover the monthly payments and to satisfy any financial covenants such as a required debt service cover- age ratio, the uncertainty in interest rates may pose more risk than you are willing to accept. As interest rates be- gin to rise, the rental income may no longer be sufficient.
Contact: Marc A. Snyder 910 Harvest Drive, Blue Bell, PA 19422-0765 • 610-260-6000 • www.kaplaw.com Other Offices: • Cherry Hill, NJ 856-675-1550 • Philadelphia, PA 215-567-3120 Kaplin Stewart At t o rne y s a t Law Getting you through the maze of real estate law. Strategy. Skill. Success.
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