LIBOR: How You Probably Got Burned

September 21, 2012

So did any of the commercial property deals you touched in the past five years or longer, including commercial property in San Diego, use financing? Let me guess: the answer is yes, of course.  

Developers acquiring or improving commercial assets such as land or buildings tend not to self-finance. They often turn instead to our pinstriped friends at the banks for adjustable-rate loans – adjustable, more or less because long-term fixed-rate commercial loans are offered less and less by banks. 

Enjoy Your Uncertainty

Why is fixed-rate financing out of favor? ”Too much risk,” mumble our pinstriped friends. That they complain about risk while having recently presided over a disaster of sub-prime, liars loans and the like, well, never mind. 

What do the loan terms do to the performance of commercial property in San Diego? Quite a bit. 

Service to these floating-rate loans to a great degree constrains what a commercial space broker can do in terms of flexibility on a lease. The way a landlord financed an improvement speaks volumes to what a broker or rep can expect to see out of the property even when perfectly matched with ideal tenants. 

To put it another way: we on the leasing side of the proposition could do our jobs perfectly, but if the loans up the line are riding an adjustable interest rate — and these days, most are — the perfect tenant and the perfect space far too often have to miss each other because cash flow and debt service raise their heads to address the uncertainty. Uncertainty we didn’t always have to deal with before, but do now. 

That’s the role of the banks: to provide capital at interest rates for the purchase of commercial property in San Diego that reflect the market for capital. But as with so many things our pinstriped friends are supposed to be doing, the reality turns out to be very different. 

Gosh, This Thing We Sold You Looks Risky: Good Thing We Sell Protection From It, Too 

Most variable-rate loans get the varying rate from one of the numbers published daily as LIBOR – the London Interbank Offered Rate. The problem with variable-rate loans, of course, is that they tend to make it impossible to know the total borrowing cost. Which is why our pinstriped friends offer the chance to exchange, at some point down the road, the variable-rate with a fixed-rate that’s higher. This is called the swap. It, too, is keyed off of LIBOR. 

So the banks, rather than accept the uncertainty of a fixed-rate long term loan, pass along to our industry the uncertainty of floating interest rates, then sell us the protection against floating interest rates.

That’s a lot of dependence on LIBOR. 

Wouldn’t it be incredible if it turned out that the constantly-adjusting interest rates our pinstriped friends used to sell us the capital we need, then sell us the protection against the uncertainty of constantly-adjusting rates…were fixed? 

By “fixed” I don’t mean “not floating”. In this case, I mean “fixed” as in a “fixed fight” — a corruption, a cheat, a scam. Rigged. A fraud. 

That’s exactly what it looks like today, as the lawsuits and criminal investigations pile up: http://www.youtube.com/watch?v=EYOzFwysdLg&feature=player_embedded#! 

It appears as if the LIBOR interest rate that governed your commercial property’s financing’s variable interest rate as well as the swap used to get a handle on borrowing costs was cooked for years to make member banks winners in their own derivatives trades. 

To a broker or developer of commercial property in San Diego, this means you got left holding the bag and paid too much for capital. To a tenant rep, this means you had to settle for less than the best match for space. To a leasing agent or tenant, it means part of your rent calculations went not to either party but to cover our pinstriped friends. And the list goes on and on. It looks like the entirety of our industry — and every other that borrows, which is more of less all of them — has been once again punked by an out-of-control culture in banking. 

Because keeping our pinstriped friends in pinstripes is apparently our responsibility, not theirs. 

SOURCE: Wayne Grohl, The Source – Commercial Source

DISCLAIMER: This blog has been curated from an alternate source and is designed for informational purposes to highlight the commercial real estate market. It solely represents the opinion of the specific blogger and does not necessarily represent the opinion of Pacific Coast Commercial.