Real estate investors choose between fixed and floating rate debt based on interest rate risk tolerance. Fixed rates lock in costs but cost more upfront. Floating rates are cheaper initially but expose you to rate increases.
You alluded a little bit to some of the debt structure used by the funds. You mentioned that 100% of the debt is fixed rate. Have you always done 100% fixed or is that a change? And can you talk to us about your philosophy there?
Big picture. To me it's always been critical to match your hold strategy with your debt interest rate risk strategy. So for example, if we're buying an asset and we expect to hold it seven years, then we should be trying to eliminate interest rate risk for that seven year period time as much as possible. So in our prior funds you probably saw fixed rate financing in the 70% range, where we'd lock it up for seven to 10 years kind of thing. And then maybe the other 30% we would use floating rate debt, but we'd also buy interest rate caps, meaning that the interest rate, like right now we had the short term rates went from basically zero to five and a half percent. But we bought a lot of caps that limit Church and Ray movement for three to five years to two and a half percent. So we bought caps, limited the risk of that floating rate debt. And when we did floating rate debt with a three or five year rate cap, we did that because we expected to sell that asset in the three to five year window. So you want to avoid prepayment penalties and other things that are expensive, non whining debt. So the general philosophy, eliminate interest rate risk as much as possible. In your strategy, let us focus on how we grow the business, how we can grow the rents, how we can reduce expenses, how we can grow the the bottom line profitability of these properties and not be taking much risk in the form of interest rate risk. And then on top of that we just do lower leverage. Our industry allows you to go to 75 to 80% debt. We've been consistently in a 60, 65% debt range. Because I've lived through cycles. I mean I've been around 35 years. I see what, I've seen what happens in cycles. And this time there's economic impact as well as interest rate impact. And you can get really hurt. And the way you preserve your capital, the way you protect your capital is minimize that debt risk as much as possible, minimize that interest rate risk as much as possible. You can't completely eliminate it. In our older funds we have insurance caps are now expiring at the end of this year and then next year. So you got to make sure that you can withstand that. But it's a much bigger difference if you're a 60% levered or 65% levered, and you lose, you know, 10, 15% of your gross revenue. You still have no problem paying your bills, you know, but if you're 8% levered, you're in trouble. And then if you're interested in leverage and you're floating right, that you're losing your equity. And the reality is these are cycles that run, and you just got to manage through the cycles so you don't lose your capital in investing in private real estate. And you shouldn't if you're. If you're disciplined.
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