Interest-Rate and Refinance Risk: The Part of a Multifamily Deal Most Likely to Break

When an apartment investment goes badly, the story is rarely that residents stopped paying rent. Far more often the property performed roughly as expected and the financing did not: a floating rate reset upward, or a loan matured on a date the borrower could not choose, into a market that had repriced. The building was fine. The capital structure was not.

This is the risk least visible in a marketing package and most worth understanding, whether you underwrite deals yourself or read someone else’s.

Two different risks wearing one name

Interest-rate risk is the risk that your borrowing cost rises while you hold the asset. It applies to floating-rate debt, where the coupon moves with an index — comfortable when rates fall, punishing when they rise. Fixed-rate debt eliminates it for the term.

Refinance risk is the risk that the loan comes due and the replacement loan is worse, smaller, or unavailable. It applies to every loan, including fixed-rate ones, because commercial mortgages are not thirty-year fixed household loans. A typical apartment loan amortizes on a 30-year schedule but matures in five, seven, or ten years, leaving a large balloon balance due on a specific date. Locking a rate does not remove that date. It just tells you exactly when you will have to face the market again.

The arithmetic, illustratively

Take a $6.0 million loan on a 30-year amortization schedule. At 5.75%, annual debt service is roughly $420,000. At 7.5%, the same balance costs about $503,000 — an increase of $83,000 a year that has nothing to do with the property.

Suppose net operating income is $588,000. Against the 5.75% loan, that is a debt-service coverage ratio of 1.40x — comfortable. Against the 7.5% loan, coverage falls to about 1.17x. Nothing changed at the building; the cushion simply thinned by a quarter. To restore 1.40x coverage at the higher rate, NOI would need to reach roughly $705,000 — about 20% higher than where it started, purely to stand still on the coverage ratio lenders actually test.

Two further consequences actually force the sales. Lenders size new loans to a coverage minimum, so a higher rate means a smaller loan against identical income — and if it is smaller than the maturing balance, someone writes a check for the difference. Higher rates also push cap rates up, lowering value at precisely the moment you need the property to appraise. Both pressures arrive together, because they share a cause. These figures are round and illustrative, not a live deal; the structure of the problem is what transfers.

Why 2020–2022 vintage deals struggled

The recent past is an unusually clean case study. A large volume of apartments was bought in 2020–2022 on short-term floating-rate bridge debt, often two or three years, assuming rates would stay low and the property would refinance into cheap long-term debt after a renovation. Rates then rose sharply. Coupons repriced within months, cheaply purchased rate caps expired and cost multiples of their original price to replace, and the permanent loan that was supposed to arrive came in smaller than the bridge loan it had to retire.

Many of those properties were operating acceptably; their sponsors still faced capital calls, forced sales, or lost equity. The lesson is not that leverage is bad — it is that short leverage on a long business plan turns an operating investment into a bet on credit-market timing.

The defenses, in rough order of usefulness

• Term longer than the business plan. If the plan takes three years to execute and the loan matures in three years, there is no room for a bad year. Debt whose maturity comfortably outlasts the work — with extension options that are genuinely exercisable, not conditioned on performance tests you may miss — is the single most valuable protection available.
• Fixed rate, or a real cap. Fixed-rate debt removes the reset entirely. If a deal uses floating debt, the questions are the strike price of the rate cap, when it expires, and what it will cost to replace — because cap pricing moves with rates, and it is most expensive exactly when it is most needed.
• Lower going-in leverage. Every point of leverage not taken is a point of refinancing exposure not created. Modest leverage is the least clever and most reliable defense there is.
• Amortization. Interest-only periods flatter early cash-on-cash returns and leave the full balance outstanding at maturity. Paying principal down builds equity that absorbs a lower future valuation.
• Assumable debt. Taking over an existing low-rate loan can sidestep the current rate environment altogether, though it comes with its own constraints — see how assumable debt works and what it costs.

What to ask before you rely on a projection

Five questions cover most of it. When does the loan mature, and how does that date compare with the business plan? Fixed or floating — and if floating, what is the cap strike and expiry? Are the extension options unconditional? What refinance or exit rate does the model assume, and what happens to coverage and returns if it is 150 basis points higher? And what is the plan if the property cannot be refinanced or sold on schedule?

That fourth question is the one worth insisting on. A model that assumes an exit rate below today’s is forecasting a friendlier future, and a forecast is not a plan. Stressing the refinance rate and the exit cap rate is standard practice in our own underwriting for the same reason we test how far occupancy can fall before a deal stops covering its debt: the assumptions worth examining hardest are the ones we do not control. Financing risk is the clearest example of that in the entire business — and real-estate investments can lose value, including all capital invested, when it is underestimated.