How We Think About Risk in a Higher-Rate Environment

The 2020–2021 debt environment was an outlier—not a baseline. Sub-3% agency debt and abundant capital created a cost-of-capital regime that few sponsors alive had experienced. Deals that penciled then often relied on assumptions that cannot be replicated: near-zero refinancing risk, minimal debt service, and compressed yields.

Higher base rates raise the required going-in yield and compress the margin for error. A deal that worked at 3.5% leverage now requires higher NOI, lower purchase price, or both. The math is not optional. When debt costs reset, so does the return profile—and the deals that survive are the ones that were structured for variance, not perfection.

Waiting for rates to drop is not a strategy. It is hope. Survivability is the strategy: can the deal refinance under stressed terms? Can it generate cash flow if the exit is delayed? Can it absorb operating variance without breaking equity? These are not hypothetical questions. They are the underwriting.

The "maturity wall" is not a macro concept—it is a deal-level vulnerability. What matters is the ability to refinance at unknown terms. A bridge loan maturing in 2026 may have looked attractive in 2021. Today, it is a binary outcome: refinance at higher rates and lower proceeds, or sell into a market with fewer buyers and compressed pricing.

DSCR-driven lending means NOI volatility matters more now. Lenders are not underwriting to projected rent growth or best-case operating expenses. They are stress-testing coverage ratios under conservative assumptions. If the deal cannot support refinancing at 1.25x–1.35x DSCR with realistic NOI, the refi will not happen—or it will happen at terms that break the equity.

A strong refi plan is not one that assumes cap-rate compression or a return to 2021 debt terms. It is one that models the maturity explicitly and survives conservative assumptions about rate, proceeds, and coverage.

• Base case refi: conservative rate + amortization + DSCR
• Stress refi: higher rate + tighter DSCR + lower proceeds
• Severe: no refi available → evaluate runway and alternatives

Rent growth is the least reliable lever in a reset. It depends on employment, supply, and demand elasticity—none of which are under the sponsor's control. Underwriting to 4% annual rent growth in a market that has averaged 2.5% over a full cycle is not conservative. It is speculative.

Expense variability is rising faster than rent in many markets. Insurance alone has repriced 30–50% in coastal and high-risk markets. Property taxes follow assessed values—with a lag that cuts both ways. A deal that underwrites to stable or declining expenses is not accounting for the operating environment.

Durable cash flow means coverage under realistic assumptions, reserves that can absorb variance, and runway that does not require perfect execution. If the deal only works when rent growth exceeds expenses and the exit happens on schedule, it is not durable. It is a timing bet.

Cap rates reflect the cost of capital, the risk premium, and liquidity—not sponsor optimism. When the 10-year Treasury moves 200 basis points, cap rates follow. Deals that underwrote to 4.5% exit caps in 2021 are now facing 5.5–6.5% reality. The math does not care about the original underwriting.

Transaction volume dropping matters. Fewer buyers means less price discovery and longer time-to-exit. A market with 30% of prior-year volume is not liquid—it is selective. Sellers who need to exit face pricing pressure. Buyers who can wait have leverage. This is not temporary dislocation. It is the market repricing risk.

In this cycle, time is a risk factor—not a neutral assumption. Our rule: exits must work without aggressive multiple expansion. If the deal requires a compressed exit cap or a return to 2021 valuations, it is not an exit plan. It is a hope.

We adjust underwriting to reflect the cost of capital, the refinancing environment, and the transaction market. This is not about being bearish—it is about being realistic.

• Prefer fixed-rate or long-term rate protection; avoid near-term maturities
• Require stronger DSCR / coverage and realistic refi proceeds
• Underwrite normalized or expanding exit cap rates
• Demand meaningful contingency reserves and operating cushion
• Favor business plans with limited execution complexity
• Prioritize sponsors with demonstrated cycle experience