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Forward funding strategies

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According to Trepp Analytics, in the coming three years commercial real estate loan maturities will hit record highs, reflecting the high volume of fixed rate, term loans placed at the height of the last cycle (2004 to 2007).

Fortunately, these loans are maturing into a recovering economy and a low interest rate environment. Many borrowers, confronted with maturing loans, are opting to take advantage of “forward funding” or “blend and extend” strategies. These strategies allow a borrower -- concerned about future increases in rates -- to take advantage of today’s rate environment, hedging against potential higher rates at the time their loans mature. Forward funding features are, for the most part, the domain of the life insurance lenders, who typically offer fixed-rate permanent loans. These lenders are busier than ever, have lent more than $50 billion in 2013, and widely expected to exceed this number in 2014. Most life companies can offer forward and many can fund as far forward as one year.

The forward funding mechanism typically works as follows: If a borrower has a fixed-rate loan coming due, say next September, they can execute a commitment with a lender now to provide the requested financing, at a fixed rate, locked today. The forward loan commitment usually is scheduled to fund at the first prepayment window or date of maturity on the existing loan.

Lenders charge a rate or “spread” premium for this feature, but it is relatively inexpensive and will still, in all probability, ensure a new, lower rate than the rate on the maturing loan. The pricing for a forward usually includes 90 days free and four basis points (or 4/100’s of 1 percent) for each month beyond 90 days. If the new rate quoted today is 3.75 percent for a 10-year loan, then forward delivery pricing for that loan into September would involve going nine months forward. Since 90 days, or three months, are "free,” the lender will charge for six months of the forward term at about four basis point per month, or 24 basis points total. The forward rate, then, would be 3.99 percent (3.75 percent today’s rate +.24 percent forward premium = 3.99 percent). Hence, if a borrower thinks rates could be more than ¼ percent higher in the next nine months, a forward commitment is an efficient way to manage that risk and sleep a little easier into the coming year.

HFF (Holliday Fenoglio Fowler L.P.) and HFFS (HFF Securities L.P.) are owned by HFF Inc. (NYSE: HF). HFF operates out of 23 offices nationwide and is a leading provider of commercial real estate and capital markets services to the U.S. commercial real estate industry. HFF together with its affiliate HFFS offer clients a fully integrated national capital markets platform including debt placement, investment sales, equity placement, advisory services, loan sales and commercial loan servicing. For more information, visit hfflp.com or follow HFF on Twitter @HFF.

-Submitted by Tim Wright, senior managing director, HFF.

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