Commercial Investment Real Estate July/August 2019 | Page 17

Table 2: At what Interest Rate is Leverage Neutral? No Leverage rates rise, the increasing mortgage payment reduces the property’s cash flow after debt service. A lower cash flow after debt service reduces the property’s cash-on-cash return. To reverse this trend, property values need to be adjusted downward to compensate for higher interest rates. Why should we care when a market enters a negative leverage environment? Negative leverage is another sign the real estate market cycle may be headed for a contraction, along with: • Rising interest rates. • Moderating rent increases. • More product coming online, slowly increasing vacancy rates and eventually leading to concessions. • More regulation to restrict property owners. In the past six months, interest rates have dropped, putting much of the U.S. back into a positive leverage environment, though some primary markets such as New York, Chicago, and areas of California may remain in a negative leverage space. Still, if interest rates rise, this situation could change. If markets move back into negative leverage environments, buyers will eventually realize that it’s better to pay the capital gains taxes than to buy an overpriced property. Cash Flow Before Debt Service Proposed Mortgage Amount Interest Rate Amortization in Years Annual Mortgage Payments Cash Flow After Debt Service Equity Cash-On-Cash Return 50% Leverage 65% Leverage 75% Leverage 227,369 227,369 227,369 227,369 – 1,837,500 2,388,750 2,756,250 4.65% 4.65% 4.65% 4.65% 30 30 30 30 – 113,698 147,807 170,547 227,369 113,671 79.562 56,822 3,675,000 1,837,500 1,286,250 918,750 6.2% 6.2% 6.2% 6.2% Table 3: Example of Positive Leverage No Leverage Cash Flow Before Debt Service Proposed Mortgage Amount Interest Rate Amortization in Years Annual Mortgage Payments Cash Flow After Debt Service Equity Cash-On-Cash Return 50% Leverage 65% Levereage 75% Leverage 227,369 227,369 227,369 227,369 – 1,837,500 2,388,750 2,756,250 4.00% 4.00% 4.00% 4.00% 30 30 30 30 – 105,270 136,851 157.905 227,369 122,099 90,518 69,464 3,675,000 1,837,500 1,286,250 918,750 6.2% 6.6% 7.0% 7.6% Doug Marshall, the founder and president of Marshall Com- mercial Funding Inc., in Portland, Ore., recently published a book, “Mastering the Art of Commercial Real Estate Investing.” Contact him at [email protected]. Lifelong Learning Access complimentary education and research to help you adapt and thrive Free to all CCIM Institute members, CCIM Institue offers complimentary webinars and industry reports which cover a variety of topics affecting your business, including blockchain, lease accounting, tax policy, real estate market cycles, and more. To learn more and gain access, visit www.ccim.com/members-only CIREMAGAZINE.COM July | August 2019 15