In a high interest rate
environment, just what are the

effects on a real estate
syndication or real estate fun?

They must surely it must have
effects. In this video, we're

going to go through exactly that
topic.

My name is Tilden Moschetti. I
am a syndication attorney with

the Moschetti Syndication Law
Group. One question that always

is in the back of all my
syndicators and all my fund

managers head is what is going
on with interest rates, I often

get asked, What do I think was
gonna go on with interest rates?

Well, let's go through exactly
what that effect is where I

think it's generally going and
hopefully, that'll give you some

guidance. So what the interest
rate risk is, obviously, is in a

very high borrowing environment.
So when interest rates are very

high, it is going to have a
problem with the cash flow and

probably the appreciation of
your property, right. So that

IRR is going to get compressed
when interest rates are up if

you have debt on the property.
Now, there's two things kind of

going on at the same time. So
we've got that pressure that

takes place if you have debt on
the property. But one thing I

don't want to leave out is that
second area, and that second

area is if we've got high
interest rates, we probably also

have a lot of products on the
market that are paying investors

a return in order to save money,
for example, in CDs, something

like that, we have a return
that's getting paid right now

that return can be around four
or 5%. So an investor

automatically can make in very
safe money, not perfectly safe,

but very safe. Money can put
money into a bank, make four or

5%. Now if your risky real
estate deal is paying four or

5%. Why on earth would they take
it, so that's obviously a

negative factor that goes on to
it as well. Now that other piece

of it is the borrowing is the
rate that you're borrowing. So

we call this this whole entity
of how the money comes in the

capital stack. Normally, there's
two pieces there, there's two

components into the capital
stack, we've got debt. So we've

got money from a lender from a
bank, something like that. And

then on the other hand, we have
money, that is the shareholder

equity piece, that shareholder
equity piece may look a lot like

that. Or it might just be pure
equity, that will you know, that

beneficial ownership. So the
benefits of the investor is they

might even just be getting a
fixed rate payment, or they

might be getting the benefit of
actual ownership and that

appreciation, it depends, it
depends how you set up your

syndication or fun as to which
they're going to get. So we've

got these two things as part of
the capital stack, we've got the

the the equity side, and we've
got the liability side, now

lenders are always on the debt
side, it gives them a lot more

power, it gives them a lot more
control, they have the ability

to foreclose on the property,
the ability to take that

property back to sell it, and to
be able to recoup their losses,

right, that's what they have.
That's the main piece of the

liability side that a lender
wants to be able to get rid of

their risks that they're not
going to be paid. Now, the

reality is on the syndication
side, is we have it the

shareholder equity piece, right,
that shareholder equity is not

subject to foreclosure. So your
investors actually do have an

increased risk over the bank.
Now the benefit to you is that

you, you know, there's less
scrutinizing the terms, you have

to find the investors that are
willing to do it. And most of

the time, in order to do that,
you have to pay them at a higher

rate. So in order to pay them at
that higher rate, the benefit to

you is you don't have that risk
of foreclosure, the benefit to

them is they get a higher rate.
So that spread that difference.

It's always a balancing act,
you're trying to figure out

which is better for your deal.
Some deals, you're going to do

all shareholder equity, you're
just going to load up on that

it's going to be an all cash
deal. Where all everything like

takes place at the shareholder
equity side. The benefit here is

that suddenly now we can
refinance the property we can

take on bank debt, because bank
debt doesn't care at all about

the shareholder equity, not only
does it come before shareholder

equity, but it also has that
ability to foreclose. If you had

given the shareholders a
possibility of being able to

foreclose, you're not going to
get a bank that's willing to

lend on it. It's not gonna
happen. Even if they've got

priority. They're not going to
do it. Now they've got an

increased risk that somebody
who's in a secondary position

can take them out. So that's
kind of a long explanation of

the capital stack of things. We
think about as it relates to

them. So the interest rate risk
is understanding how that plays

in. So we've got those two
competing forces, we've got

possibility of high interest
rates. And we've also got the

shareholder expectation of what
their return should be. Now,

we've also got the risk
mitigation thoughts that need to

take place. Now one strategy
that you can do, because if I'm

going out, and I go to a bank,
and I say, I need to finance

this property at 50%, loan to
value, and I've got these other

shareholders here, they're not a
part of this necessarily. But I

need to get a 50% loan to value.
I answered, the bank comes back

and says, Okay, no problem,
we're going to give you a loan

for that amount, and we're going
to do it at 10%. Because it's a

we've considered a somewhat
risky steal, and so that it's

going to be temporary. So but
guess what, because we don't

know exactly where interest
rates are going, we're going to

pay it to something like LIBOR.
And we're going to make it a

variable interest rate loan. And
so although it's 10 years, it

adjusts every quarter. And we're
going to do it over the next

five to 710 years, whatever that
determines. And it's going to be

variable. Now, you may say, as
the asset manager, oh, okay,

that's great. Because when at
when, when the rates go down,

I'm going to do better, right,
so now my payment goes less my

IRR is go up your rate your
everything's winning. But what

if those rates go up? What if
you've decided, no, I'm not

exactly sure where it goes. I
mean, where I sit today, we've

already seen, oh, inflation
might be still pressing. And

finally, the the perceived
inflation from the Fed might be

saying, let's keep interest
rates higher, maybe they'll

decide let's bump it up a little
bit more, either. All right.

What if it? What if the what if
inflation jumped to 4% or 5%,

next quarter, suddenly, there's
going to be this increased

pressure from the Fed in order
to over to raise rates, and

that's going to drive our
interest rate for that loan

that's paid to LIBOR, it's going
to make those payments higher.

Now, suddenly, everything we've
promised the investors is, is in

trouble. So how do you mitigate
this risk? Well, what you can do

is you can buy what's called an
interest rate swap. What that

does is it says, you go to
somebody who based and you

basically say, look, I've got
this variable rate loan, I want

to buy a fixed rate loan, I want
to basically trade it in, let's

give, let's trade our payments,
you take on the variable

interest rate, you take on the
fixed rate interest, or the

variable interest rates that
I've been paying. And I'll take

on the fixed rates that you're
willing to give me, and you're

gonna make money through that
spread. And I'm willing to pay

for that. So what that does is
it gives you that fixed rate,

well, I'm stuck at 10%. But at
least it's not going to go to

12. So at least your numbers
aren't going to be thrown off.

So there's risk that on the
other side of okay, I've done

that. But what happens now, when
interest rates fall, what if

interest rates fell to five?
What if they fell as low as

we've seen, like 3%, or just
under 3%? Oh, my gosh, she just

made a big deal. But he made a
very bad decision. So you can

actually do the opposite. So say
the bank had given you a fixed

rate loan, you can actually sell
that fixed payment, you can

trade those though that cash
flow that you're paying on the

fixed rate, and turn it into a
variable rate and peg it to

something like LIBOR or
something like that. So you can

actually buy a swap that goes
the other way. Now, of course,

the risk is that interest rates
go up, and now you're back up

that 12% 12% interest rate. So
that's sort of the the thoughts

that go into the risk mitigation
piece. The last topic that I

want to talk about is the impact
on valuation. So if I'm buying a

single asset, or I'm buying a
multiple pool of assets,

valuation of the individual
assets is going to change based

on interest rates. And why is
this because cap rates are

somewhat correlated to the, to
the value of the asset. So cap

rates generally go up after some
period of time after the

interest rates go up. Now, why
is this because people want to

make money from their assets,
right? So if cap if interest

rates go up and the borrowing
power that makes it so it's I'm

getting less cash flow from it,
they still have to, they still

want to enjoy that cash flow.
The only way to make up of that

spread between the the cap rate
and the interest rate is to

increase the cap rate. So the
only way the buyer of a

potential property we'll be able
to do that is to is to buy at a

higher cap rate. This can change
that valuation period. So what

this means is that You may be at
risk if interest rates go up of

having your values of your
properties actually go down.

Because remember, if cap rates
go up, that price goes down.

So what but it also introduces
another kind of issue, perhaps

there's an arbitrage
opportunity. If you feel very

confident in the next three
years that interest rates are

going to fall. And you're able
to buy as if that interest rate

is at this level, and so the cap
rate is up here. And suddenly

the interest rate is here. Well,
now suddenly, you can sell with

a cap rate here, which means a
lower cap rate means higher

price. So that means you've just
made a massive amount of money

for your investors just on the
natural changes in the interest

rate itself. Now, I hope this
video helped kind of put some

perspectives on things that go
through my head when I do my own

deals as it relates to interest
rates. I also work with clients

for as a real estate syndication
attorney and help that guide

them through the legal aspects
but also because I have so much

experience in doing real estate
syndications for me, I'm openly

share that if that information
with my clients. Now if I can

help you, we'd welcome a call.
Let's talk about your project,

what you're working on and see
if we have a good fit and maybe

we can work together