What it is
SOFR, the Secured Overnight Financing Rate, measures the cost of borrowing cash overnight with U.S. Treasury securities as collateral. The Federal Reserve Bank of New York publishes it each business day. It replaced USD LIBOR as the standard benchmark for floating-rate loans in the United States; the remaining USD LIBOR settings stopped being published on a representative basis after June 30, 2023.
How floating-rate CRE loans use it
Most floating-rate commercial real estate loans, including many bridge and construction loans, are priced as an index plus a spread:
Loan rate = SOFR (or Term SOFR) + spread
The spread is set by the lender based on the deal's risk. The index moves with the market. If the index rises, the borrower's rate and debt service rise with it.
Term SOFR
SOFR itself is an overnight rate. Many CRE loans instead use Term SOFR, a forward-looking rate for a set period, usually one month, published by CME Group. That lets borrowers know their rate at the start of each interest period. Some loans use compounded or average SOFR instead. The loan documents specify which.
Floors and rate caps
- Floors. Many loans set a minimum index rate. If SOFR falls below the floor, the borrower still pays the floor plus the spread.
- Rate caps. Lenders on floating-rate loans often require the borrower to buy an interest rate cap. If the index rises above the cap's strike rate, the cap provider pays the difference, limiting how high debt service can go. Caps cost money upfront, and the cost rises with rate volatility and the length of the cap. Extension options often require buying a new cap.
How lenders underwrite it
Because payments can change, lenders often test coverage at a stressed rate, or at the cap's strike rate plus the spread, not today's rate. A deal that shows a comfortable DSCR at the current index may look tighter under that test.
Example
| Item | Illustrative value |
|---|---|
| Term SOFR | Index rate on the reset date |
| Spread | 3.50% |
| Floor | Index cannot fall below the stated floor |
| Rate cap strike | Index above this is covered by the cap |
The numbers are illustrative. Index levels change daily; check the current published rate before quoting.
Common mistakes
- Quoting all-in rates from last month. The index moves. Quote the spread and the index source.
- Leaving cap costs out of the budget. On a bridge loan, the cap can be a meaningful line item.
- Ignoring floors. A floor can make a "floating" loan behave like a fixed one when rates fall.
In the package
State the rate structure you're requesting, and show DSCR at the stressed rate a lender is likely to use.