SOFR

SOFR: What the Market Actually Requires

SOFR pricing shows up wherever CRE debt floats: bridge loans, debt fund paper, bank construction and transitional loans, and the floating tranches of larger capital stacks. The operative index for most CRE loans is 1-month Term SOFR, a forward-looking rate published by CME, rather than the daily compounded averages more common in corporate credit. Because SOFR is secured by Treasury collateral, it is a nearly risk-free rate and runs structurally below where LIBOR, an unsecured bank rate, would have printed; legacy loans that converted at LIBOR's cessation picked up a fixed spread adjustment to compensate.

Two loan terms travel with SOFR on every floating deal. The first is the floor: lenders set a minimum index level, frequently at or near the index level at closing on new originations, so their coupon cannot ride a rate rally downward. The second is the interest rate cap, which most floating-rate lenders require the borrower to purchase from a third-party provider. The cap pays out when the index exceeds a strike price, limiting the borrower's exposure; its upfront cost scales with the strike level, the notional amount, and the term, and cap pricing swings dramatically with rate volatility. Loan documents typically require replacement caps as a condition of extension options, and servicers escrow monthly for the replacement cost, a cash drag sponsors routinely forget to model.

The underwriting discipline is to stress the deal at the cap strike, not at the current index. A bridge loan that covers comfortably at today's SOFR but breaks even at the strike is a deal that only works if rates cooperate. Sophisticated sponsors also negotiate the interplay between terms: a low floor is worth little if the spread is wide, and a cheap cap at a high strike protects the lender's collateral more than the borrower's cash flow.

Why It Matters for Your Loan

Every floating-rate dollar in a capital stack reprices with SOFR monthly, so the index drives cash flow, DSCR covenants, extension tests, and the real cost of the required rate cap. On a $10,000,000 bridge loan, each 100 basis points of index movement changes annual interest by $10,000,000 x 1% = $100,000. Commercial Lending Solutions structures floating-rate requests around the full package, spread, floor, cap strike, and cap cost, because lenders quote them as separate line items that only make sense priced together.