Interesting Signals

For those sniffing out possible troubles ahead for commercial real estate, add this one: The huge growth in interest-only (IO) loans over the past three years. As of January 1, 55.8% of all fixed-rate conduit loans featured IO periods—up from 5.9% at the beginning of 2002. And 35.6% of these loans are IO for the full term, according to an analysis by Moody’s Investors Service.

Why worry? Because the jump in IO loans may be a signal of loose underwriting standards and emblematic of a speculation-driven market: For a borrower who is intent on flipping assets, IOs make sense: By the time the loan requires him to pay back the principle, he’s on to another deal. As long as it’s a seller’s market, that is. If rising interest rates or other factors stop the price spiral and deal frenzy, IO buyers will be stuck. They will wind up paying the principle—if they can.

This article was published on May 4, 2005 by Parke Chapman with the National Real Estate Investor. Click here to link to their site and the full article.