The Death of LIBOR Will Have Minimal Impact on U.S. Real Estate Loans According to CapStack Partners' CEO, David Blatt

In light of the numerous industries that have been upended by new, disruptive business processes in recent years, the recent announcement of LIBOR's demise and replacement by the end of 2021 is being met with reactions ranging from indifference to puzzlement. It's no help that the pundits elaborating on the decision and transition process tend to be economists and government bankers that are providing explanations primarily directed at each other. But what does this change mean for real estate investors?

Commercial real estate borrowers recognize LIBOR as the benchmark typically used to price the interest rate for bridge and construction loans as well as certain securitized loans. A developer's LIBOR-based loan typically resets on a monthly basis and impacts the payment accordingly. However, the input that affects that rate output is where things become less clear. A simple primer on how LIBOR is determined is as follows: Each day, a group of banks estimate their cost to borrow short-term funds from other banks and report that to the UK's Financial Conduct Authority (FCA), hence London Interbank Offered Rates or LIBOR. LIBOR is then set based on an average of the estimates. In reality, LIBOR is no longer reflective of true borrowing costs because banks tend to borrow from central banks, rather than each other. Additionally, banks have recently been caught manipulating the rate for various self-serving reasons. LIBOR's exit is intended to be replaced with an index of actual market activity by the end of 2021.

In June, the Alternative Reference Rates Committee (ARRC), a Federal Reserve-based committee, landed on the Broad Treasury Financing Rate (BTFR) as the U.S. benchmark to replace LIBOR. As noted in a recent Bloomberg article, this new rate will begin publishing daily in early 2018. The CME Group, parent of the Chicago Mercantile Exchange and member of ARRC, also announced that it is preparing to launch futures and options based on the published BTFR. It is expected that new loan originations using the new U.S. benchmark will occur shortly thereafter. The impact of a benchmark correlated to U.S. debt will be minimal for new loan originations. Five, seven and ten-year loans are already priced using U.S. Treasuries, or their swaps, as their benchmark.

As it relates to existing loans using LIBOR, we don't expect much impact either. Short-term loans will have been repaid before 2022. Loans that mature past that date are already revising their documents to anticipate swapping a substitute benchmark.

While there are considerations related to revising these future legacy loans, and certainly negotiations between borrowers and lenders to be had, we fully expect that all will be well and done in time. Fundamentally, the system of lending and borrowing money to finance real estate acquisitions and development projects is sound and we trust in the motives of both sides of that trade to maintain that system. So, while a long used benchmark in LIBOR is going away, commercial real estate borrows will continue to have access to capital at terms based on a more reliable volume of actual transactions.