What 5% Actually Changes

Howdy — something shifted in the debt market last month, and it is worth starting there rather than easing into it.

For most of the last decade, the working assumption underneath a lot of real estate was that rates would eventually come back down. July made that assumption harder to hold.

That reporting comes from GlobeSt and CRE Daily. The headline is the rate. The part that matters more takes a minute longer to see.

The loan shrinks before the price does

A higher rate does not simply raise the payment. It raises the mortgage constant, which tightens the debt service coverage test, which reduces the loan a lender will actually write. Proceeds get cut before anyone sits down to negotiate a purchase price.

That reframed how my own numbers look to me. My coverage floor sits at 1.40x, meaningfully tighter than what agency programs typically require. Running that floor across my cap rate range showed it caps leverage well below the loan-to-value range I had written into my buy box.

The loan-to-value number was decorative. Coverage had been doing the work the whole time.

Proceeds are not a property fact. They are a lender fact.

Lenders are not all moving the same direction

The second story in July was the split. One large lender pulled back hard while several peers expanded at the same time, in the same market, under the same rate environment.

The Federal Reserve reported total bank commercial real estate loans reached $3 trillion in June. Mortgage Bankers Association data showed $455 billion in first-quarter originations, up 80 percent from a year earlier, concentrated in multifamily and data centers. CRE Daily covered both sides of it.

So capital is back. It is just selective.

That distinction matters more to me than the headline. When lenders get choosy, the operator stops being a soft factor sitting off to the side of the analysis. Sponsor strength moves proceeds and pricing directly, which means two identical buildings under two different sponsors are not the same deal. The lender prices that difference before anyone signs anything.

Worth watching alongside that: when proceeds tighten, the intermediary layer gets busier. More people appear offering access to capital. The question worth asking early is which fees are contingent on an outcome and which get paid regardless. That answer tells you a good deal about who is carrying risk next to you.

How this changes the underwriting

This is where it stops being commentary. A few things get tested differently now:

• Coverage run at today's rate, not a blended historical assumption
• Amortization examined alongside the rate, because both drive the payment
• Interest-only treated as a proceeds tool that earns scrutiny, not enthusiasm
• The refinance test run out loud: at today's rate and today's income, what does this asset size to
• Exit assumptions built without help from cap rate compression

Whether all of that means my buy box needs a fourth test sitting alongside occupancy, cap rate, and coverage is something still being worked through on my end. Not ready to plant a flag on it yet.

One market I'm studying: El Paso

Here is why that first number reads differently now than it did two years ago. In a 3 percent rate world, a going-in yield premium is a footnote. At 5 percent, it is most of the margin of safety. The spread between what an asset yields and what the debt costs is the whole cushion, and El Paso has historically offered more of it than the larger, more heavily traded Texas markets.

Now the other half, because a premium always exists for reasons. The buyer pool there is thinner, income growth is modest, and population growth is slow. Sophisticated buyers price all of that. So we underwrite flat to wider exit caps and assume no help from cap rate compression at sale.

A yield premium is not a reward. It is compensation for risk that somebody else already priced.

The work is deciding whether you are being paid enough for the specific risk you are actually taking.

One real question for you this month. For those who have owned real estate through a rate cycle before, what do you wish you had underwritten differently going in? Hit reply, I read every one.