Continued from Part 80 . . . Determining the Mean

The mean is the statistical determination of “average”. The mean of 10+10+30 is 16.67. That is also the average. Both words refer to the same result, but with a small difference. Generally, “average” is used to imply a WAG (Wild Alcoholic Guess), while “mean” suggests a calculator was involved.

In this case, a cheap calculator was used to add the annualized rates of 10-year Treasuries during the 50 years prior to 2018. The sum was then divided by the number of data points taken (50), and it was found that the mean interest rate over the past half-century for 10-year Treasuries was 6.27%. This data point can inform the (a) refinance, (b) purchase, and (c) sale decisions.

Standard Deviation

The standard deviation (SD) is a measure of central tendency. One SD contains 68% of the measurements, half on the left side of the mean and half on the right side.

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Between 1968 and 2018 the standard deviation of the 10-year Treasury was 2.98, indicating that 68% of the time rates ranged from 3.29% to 9.25%.

This becomes important when evaluating the risk of a variable rate loan.

Reversion Towards the Mean

It is necessary to know the Long Term Mean to develop future interest rate trends. An appropriate data set causes the mean to become sufficiently robust that prediction of the trend in future interest rates become viable. Current rates above the mean will eventually fall, and rates below the mean will rise, over time, and trend upwards towards the mean.


Mortgage rates consist of the sum of (a) the index and (b) the margin. The margin is determined by the lender, and is the fixed rate portion of the total interest rate, generally somewhere between 2.5% and 3.0% depending on the lender and the loan’s perceived risk.

The index, often the 10-year Treasury, adjusts either up or down as the market breathes. Using the 50 year average rate for the 10-year Treasury note index, mortgage rates should now be much higher than they are. The average long term index rate of 6.27% plus a margin of 2.75% add up to 9.02%.

To put this into perspective, on the day this was written the 10-year Treasury was yielding 2.41%. Adding a typical margin, the expected interest rate on a loan written today would be 5.16%.

Income property prices now reflect a 5.16% underlying interest rate. This conflicts with the normalized rate of 9.02%. If mortgage rates were at their fifty year average today’s rates would be 75% higher than they are. An example of that would be a hypothetical variable rate mortgage currently at 4.75% being repriced at 8.3%. Such an increase in mortgage rates can be expected to have a meaningful effect on values.


Historical data indicates asset values are teetering on the edge of a precipice. Eventually they will fall (and again, we don’t know when). But although rates are not as low as they recently were, they are still below their long-term average. This is the time for a thoughtful investor to lock in a favorable refi at (still) historically low rates.

Teetering as the market may be, there are still relatively few properties available and it remains a seller’s emporium. This is not unusual. It is common for markets to be biased towards the buyer or the seller. They are seldom absolutely neutral. That is normally not much of a problem, because the effect on the parties is minimized when both the sale of one property and subsequent purchase of another happens in roughly the same market (i.e., interest rates remain relatively constant). Typically, if you sell high because of the market, you’ll buy high because of the market. If you sell low, you’ll normally buy low.

Lenders, however, make investments in hot markets that they’ll have to foreclose upon in cold markets. They have a longer perspective. They look down the road and see that Herbert Stein was right: “If something can’t last forever . . . it won’t.”

Lender’s behavior is changing because they see the next half of the credit cycle approaching. This is the half when rates go up and values go down. Over the last couple of years, they have been making incremental changes to reduce their prospective losses. They have been slowly strengthening their loan portfolios. Not everybody is equal. The heightened standards don’t seem to apply to uber-elite borrowers with plenty of money in the bank, institutional-grade properties and low loan-to-value ratios. Think REITs. Those people are accommodated now almost as well as they have ever been. Such folks still have the least problem in securing funding.

But for the rest of humanity, it’s different and getting more so. There was a period (these things are cyclical: we’ve seen this before and will one day see it again) when old apartments on heavily trafficked streets in industrial areas could receive loans that were historically very favorable. This was when lenders recognized that interest rates were declining and values were going up. Even if they pushed the limits on a loan, within a year the market would go up enough to turn the loan sound. There was no need to scrutinize borrower qualifications very much. The property stood on its own. It’s different now.

Now, there’s not much that can be done if the property is poorly located. It is what it is. Few lenders accept such loans anymore. If they do make one, the rate will reflect the greater perceived risk. “Wake up, Billiam! If we have to foreclose on that thing . . . who’s going to buy it from us? And where will the new buyers get the loan?”

Still, if the property is well located but has deferred maintenance, it might be a candidate for a makeover, assuming enough money and time. Afterwards, maybe a lender could be induced to make a quote, even if unenthusiastically, on the renovated property.

Not only are properties being qualified through a finer filter, but once again, the borrower is as well. It used to be that income property stood for its own debt, but more and more lenders are looking (again) at the borrower.

One of the things lenders are looking for is liquidity. How much cash-equivalency does the borrower have? Something always comes up. Does the borrower have enough liquidity to get through it? Cash equivalents include things like savings and checking accounts, retirement funds, cash value of life insurance policies, and stock / bond portfolios.

The preferred liquidity threshold is currently hovering around 10% of the requested loan amount. For example, a $3.5 million loan would require the borrower to have proof of $350,000 in liquid funds remaining after the close of escrow, whether the escrow is for purchase or refinance. 

That is a high hurdle. A $3.5 million loan may be secured by a well-located 12 or 15 unit property. Not many folks with buildings that size have $350,000 in cash. Nonetheless, a liquidity problem, which may be temporary, is easier to manage than a poor location (which is permanent).

Nobody reading this article needs guidance on real estate investing. When about half of America has zero net worth or less (i.e., debts exceed assets), the person owning rental property is already ahead. But an awful lot of good apartment owners are not liquid. They have made fine money in real estate but most of it is in equity appreciation, not liquid cash flow. Now, however, having substantial liquidity is required for the borrower to get the best loans.

Cash is self-explanatory. It is maximally liquid (good) but subject to erosion from inflation (bad). One way to manage cash assets is by having a necessary minimum for emergencies, but not enough that the loss from inflation is crippling. One reads about portfolios with 10-20% cash, often invested in short term Treasury bills (bills: mature in less than one year) or possibly T-notes (notes: 1 -10 year maturities). When rates go up the shorter terms can be desirable because the potential for reinvesting at higher rates is present.

Once an appropriate amount of emergency savings are accumulated, the rest could be geared towards stocks or bonds (or both). The hope is that the liquid portfolio will grow at least as fast as income property values, and sometimes this happens. Two things that would be important to note in a perspective portfolio would be the Compound Annual Rate of Growth (CAGR) and the Standard Deviation (SD), which indicates risk. Most folks (but not all: people are different) would probably want a portfolio that provides the highest CAGR with the lowest SD. We’ll talk about that next month.

This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker specializing in difficult-to-place mortgages for any kind of property. If you are thinking of refinancing or purchasing real estate Klarise Yahya can help. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].