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MANAGING INTEREST RATE RISK IN REAL ESTATE DEVELOPMENT

MANAGING INTEREST RATE RISK IN REAL ESTATE DEVELOPMENT Footnotes 1 . For a catalogue of these derivative products See Clifford Smith , Charles Smithson , and Sykes Wilford , “ Managing Financial Risk ,” Journal of Applied corporate Finance (Winter 1989 ) Vol. 1 No. 4 . 2 . There are several advantages, however, to combining floating‐rate bank financing with a swap over a typical insurance company loan. For one thing, insurance companies typically require at least 85% pre‐leasing whereas banks are more flexible. Also, should interest rates subsequently fall and the developer wants to pay off the loan prior to its stated maturity and refinance at a lower rate, insurance companies require at least a “yield maintenance” penalty and may also insist on a prepayment fee to retire the loan. The yield maintenance penalty compensates the insurance company for both a decline in rates as well as their lost “lending spread” for the term of the loan. Synthetic fixed‐rate bank loans, by contrast, can be prepaid simply by repaying the floating‐rate lender with no penalty for the bank's lost lending spread over the term of the loan. However, termination of the swap, to be sure, may also require a penalty—namely, if rates have fallen since http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

MANAGING INTEREST RATE RISK IN REAL ESTATE DEVELOPMENT

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Publisher
Wiley
Copyright
Copyright © 1990 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
DOI
10.1111/j.1745-6622.1990.tb00195.x
Publisher site
See Article on Publisher Site

Abstract

Footnotes 1 . For a catalogue of these derivative products See Clifford Smith , Charles Smithson , and Sykes Wilford , “ Managing Financial Risk ,” Journal of Applied corporate Finance (Winter 1989 ) Vol. 1 No. 4 . 2 . There are several advantages, however, to combining floating‐rate bank financing with a swap over a typical insurance company loan. For one thing, insurance companies typically require at least 85% pre‐leasing whereas banks are more flexible. Also, should interest rates subsequently fall and the developer wants to pay off the loan prior to its stated maturity and refinance at a lower rate, insurance companies require at least a “yield maintenance” penalty and may also insist on a prepayment fee to retire the loan. The yield maintenance penalty compensates the insurance company for both a decline in rates as well as their lost “lending spread” for the term of the loan. Synthetic fixed‐rate bank loans, by contrast, can be prepaid simply by repaying the floating‐rate lender with no penalty for the bank's lost lending spread over the term of the loan. However, termination of the swap, to be sure, may also require a penalty—namely, if rates have fallen since

Journal

Journal of Applied Corporate Finance – Wiley

Published: Mar 1, 1990

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