For many real estate investors, mezzanine debt has become a mainstay in the capital stack in recent years and rising interest rates haven't done much to diminish its allure. Rather, investors are responding to the changing environment by using fixed-rate mezzanine debt or by capping their floating-rate obligations.
Still, many developers and investors won't have the option of converting their mezz layers to fixed-rate financing, says Raphael Bostic, director at the University of Southern California Lusk Center for Real Estate. It all comes down to the hold period, he points out, since many investors haven't owned their properties long enough for them to appreciate, preventing any opportunity to refinance at an increased valuation. Moreover, most owners feel that going through another loan process would be too lengthy and costly.
What those borrowers can do, says Lucas Donahue, a loan officer with Johnson Capital in Phoenix, is purchase caps or collars for their adjustable loans. Caps protect borrowers against rate increases throughout the term of the loan and can be purchased as separate trades from a variety of sources including local banks, investment banks and specialty mortgage companies. Collars lock in a range on a floating-rate loan, specifying a maximum (cap) and a minimum (floor) rate. A collar offers the protection of a cap, and helps investors minimize the cost by setting a minimum that your interest rate will not fall below.