Springing interest rate caps require commercial real estate (CRE) borrowers to purchase an interest rate cap once the floating-rate index on a loan reaches or exceeds a certain value. Typically, the loan documents will specify whether your loan is subject to a springing rate cap. If required, the springing rate cap must be purchased post-closing but only if the specified threshold is met.

 

Read ahead for 4 things CRE borrowers should know about springing interest rate caps.

 

The Difference Between Springing Interest Rate Caps and Traditional Caps

Unlike traditional caps, springing caps occur well after closing (if they are triggered). Also, springing caps may not always be triggered as with traditional caps. And if the springing rate cap is not triggered, the borrower does not have to purchase the cap. Conversely, traditional caps are purchased upfront with a single payment at the closing of the loan.

 

The Cause of The Springing Interest Rate Caps Influx

In June and July 2022, the Feds increased interest rates by 75 basis. Last week, On September 21st, the Fed hiked interest rates by yet another 75 basis points, the biggest back-to-back increases since the early 1980s. As a result, caps are being triggered more often, thus causing an influx of springing caps.

 

The Benefits of Springing Interest Rate Caps

Commercial real estate borrowers can benefit from springing interest rap caps in several ways:

• Springing rate caps protect borrowers from the effects of rising interest rates by limiting the total interest expense to a predefined maximum level.
• Springing rate caps are a prudent method for borrowers concerned with risk management. 
• Springing caps allow borrowers to avoid the cap’s upfront cost at the time of loan closing.

In each of these scenarios, the borrower is protected from the rapidly increasing interest rates if and when their springing caps are sprung.

 

How Can Thirty Capital Financial Help?

In the midst of rapidly changing interest rates, borrowers may find out that their caps have sprung at the last minute or even after the fact. In some cases, the borrower only has a couple of days to purchase an interest rate cap. Borrowers are likely to become frantic in this urgent situation. 

Thirty Capital Financial helps borrowers purchase interest rate caps within an average of 3-5 business days. We help identify cap counterparties, generate cap term sheets, gather and submit KYC (know your customer) information, compile required Dodd-Frank representations and get caps placed quickly. Additionally, we help borrowers set up automated alerts to eliminate surprises as they approach a springing interest rate cap.

 

Need help getting started with your springing interest rate cap? Speak with one of our experts for a review of your loan portfolio today!

What is SOFR?

SOFR is based on overnight transactions in the U.S. dollar Treasury repurchase market (Repo). It is the largest rates market at a given maturity in the world, averaging roughly $1 trillion of transactions every day.

SOFR measures the cost of borrowing cash overnight collateralized by Treasury securities. SOFR is a risk-free rate (RFR) that does not contain material term risk or bank-credit risk. 

 

How is SOFR Used?

The secured overnight financing rate, SOFR, is a benchmark used by financial institutions to price loans for businesses and consumers.

 

Which SOFR Rates Do Lenders Use?

The acronym “SOFR” itself can be misleading as it may refer to several different rates. In more specific terms, lenders use the following three types of SOFR rates to calculate interest:

• Term SOFR

Term SOFR is a forward-looking interest rate based on estimates of overnight SOFR.

• Daily Simple SOFR

Daily Simple SOFR is calculated using simple interest over the current interest period. For Daily Simple SOFR, the overnight SOFR rate is sourced daily and multiplied by the outstanding principal of the loan.

• NY Fed SOFR

For a given accrual period (commonly 30 days), the NY Fed SOFR rate takes a compounded average of the prior accrual period, such that the rate is known at the beginning of an interest period.

 

What Are the Current Rates for SOFR, Average SOFR, and Term SOFR?

The SOFR rate is reported daily at 8:00 a.m. ET by the Federal Reserve Bank of New York. The daily published rate represents the rates on overnight repurchase transactions initiated the previous business day and are to be repaid on the current business day. Below are the current SOFR, 30-Day Average SOFR, and 30-Day Term SOFR rates as of September 9th.

 

Current SOFR Rate

2.28

 

30-Day Average SOFR Rate

2.28503

 

30-Day Term SOFR Rate

2.77883

 

How Can Thirty Capital Financial Help?

Thirty Capital Financial offers consultations to help you successfully navigate the transition to SOFR. With over 45 years of collective interest rate hedging/derivatives expertise, our team is here to help you explore SOFR solutions. 

We help borrowers by talking with their lender and identifying what the best SOFR rate is for each borrower’s unique situation. Additionally, we help borrowers implement strategies to hedge against increases in SOFR, such as interest rate caps, collars, floored swaps, swaps, swaptions, and cancellable swaps.

Our consultants work hard to ensure a smooth transition to SOFR and help you get the most beneficial deal to maintain the lowest costs possible. 

 

Get in touch with one of our experts to help you calculate SOFR rates today!

Defeasance consulting is a specialized service and relationship that lasts beyond the closing of the defeasance transaction. Choosing a defeasance consultant is an important step that is often overlooked or pushed off to a third-party broker or servicer whose interests may not be directly aligned with the Borrower. Not all consultants are created equal, so it is wise to take a little time to research your options and ensure you don’t fall victim of one of the many defeasance myths.

Please note that a “closed” defeasance is not necessarily a successful transaction – inefficient portfolios and out-of-market securities pricing cost Borrowers tens of thousands of “hidden” dollars.

Choosing a consultant that is experienced in defeasance generally, as well as portfolio structuring and pricing specifically, can provide peace of mind that you are in good hands for a truly successful defeasance closing.

Even after 20 years of commercial loan defeasance practice, misinformation runs rampant through our industry every day; be wary of these 4 myths in defeasance or any facilitator that may tout any of the following:

i. We have the cheapest third party/transaction fees
ii. Securities costs should be the same from everyone
iii. We bid securities to get you the best price
iv. As your Lender/Servicer, we have synergies and efficiencies that a third party can’t provide.

 

1. We have the cheapest third party/transaction fees

Third party transaction costs represent the smallest cost component of the defeasance yet garner the most attention when selecting a defeasance consultant. On the other hand, the securities costs are the most expensive and volatile aspect of the defeasance process and the most overlooked.

Why is this the case?

Sales/marketing efforts by unnamed defeasance providers spread misinformation and half-truths to convince Borrowers that defeasance portfolios are a commodity and securities costs should be the same across the board. However, nothing is further from the truth. The newer generation of defeasance language allows for higher yielding agency securities and has, on average, longer terms to maturity (at the time of defeasance), making securities costs today much more sensitive to poor structuring and bad execution and unknowing borrowers are paying for it.

If you are being enticed by low third-party fees, buyer beware. Saving a couple thousand dollars in transaction fees could cost you many times more than your perceived savings with mismanaged defeasance securities practices.

 

2. Securities costs should be the same from everyone

Defeasance securities costs can be similar across providers for certain specific situations (generally when the loan has a very short term to maturity and/or is limited to defeasance collateral comprised of only US Treasury obligations). The last few years of rate volatility and increased defeasance activity revealed changing transaction metrics where loans were being defeased with much longer, 4–6 year, average terms to maturity compared to prior years. Current defeasance activity is comprised of a high concentration of Freddie Mac “K” Multifamily loans and newer vintage CMBS loans that have lower initial interest rates and include optionality to use higher yielding Agency securities on a broader scale. The combination of longer remaining terms and a smaller universe of less liquid Agency securities has exposed process inefficiencies in our industry – our sister company works with every defeasance provider and has given us a unique insight into the securities execution practices of our competition. The results have been eye opening, with cost differentials in the tens and even hundreds of thousands of dollars for each loan. Defease With Ease utilizes proprietary structuring processes and long-standing trading relationships to provide our clients with the best securities pricing in the industry.

If you think the defeasance securities market is the same across all providers, you are probably paying too much.

 

3. We bid securities to get you the best price

The two main defeasance portfolio execution options are competitive bids and negotiated trades.

Competitive bidding a defeasance portfolio’s structure and pricing is an archaic conceptual carry-over from the municipal bond defeasance market, created with the intent of providing municipalities with the best pricing. For anyone familiar with the municipal bond bid-rigging scandal you know this wasn’t necessarily the case. The process for competitive bidding entails the consultant sending the loan’s underlying amortization cashflows to multiple bond salesmen, usually 2-4 desks, approximately 30 minutes prior to a bid deadline. In turn, each desk will set up a portfolio based on securities they have on hand, or can locate at that moment, and subsequently submit their bid with their chosen fee embedded in the pricing. There is no time for creativity, planning or extra cost saving efforts because a mere 30 minute window is insufficient to effectively source, structure and price; moreover, securities must be available and guaranteed for delivery the following day.

Issues with competitive bids:

» Trading desk preparedness: lack of timing/focus to provide an effective bid » Some desks pass on bidding or may submit a high bid to see if anyone is willing to take it.

» Limited universe of eligible securities for your portfolio when a trader is only given 30 minutes to “submit their best offer”

» Extra layers of commissions and fees

» Traders are fully aware of the fallacies and drawbacks of competitive bids and the Borrower suffers – choosing the “best” of three poor bids is often the result.

It is understandable that Borrowers relate to the oft promoted concept where ‘seeking multiple bids’ would result in lower costs, but there continues to be MAJOR issues with the competitive bidding process and defeasance providers to this day will pitch this as an asset to their services.

Parties who tout the benefits of bidding create a significant disservice to the industry and have cost their unknowing clients millions of dollars in just the past few years.

 

4. As your Lender/Servicer, we have synergies and efficiencies that a third party can’t provide

In reality, there are no significant synergies or efficiencies created by using your Servicer as your Consultant. Having the Servicer act as your defeasance consultant is like being a defendant in a courtroom where the plaintiff, judge and jury are all the same party. Most CMBS Servicers do not have an affiliated or internal defeasance consulting arm, and for good reason. CMBS Servicers are financially obligated to represent the interests of the CMBS Trust and its investors first, so it is impossible for them to also put the Borrower’s interests first. We have helped Borrower clients navigate defeasance issues where their interests were directly adverse to the Servicer’s interests, with significant monetary value at stake.

Each Borrower has the right to engage and utilize an independent third-party advisor to represent its interests in the defeasance transaction, don’t give that right away.

 

Why Thirty Capital Financial?

 

Trust

Thirty Capital Financial has been working hard to earn the trust and respect of CMBS Borrowers and the entire CMBS defeasance industry. We pioneered the modern defeasance consulting industry, creating an organized and economical process for Borrowers to exit a CMBS loan prior to maturity. Since then we’ve closed over 10,000 defeasance transactions, structured & purchased over $100 billion in defeasance securities, and worked with thousands of borrowers, attorneys & brokers, but don’t settle for our word. We would be happy to introduce you to some of our past clients to get their feedback. We pride ourselves in providing 100% transparency throughout the transaction and will always aggressively advocate for the best interests of our clients. We guarantee the timing and execution of our services in writing and provide a level of customer service that is unmatched in the industry.

Process

As your consultant, every step of our process is structured with your interests in mind. From providing the preliminary cost analysis, to starting the defeasance process with your Servicer, through the successful closing of your transaction, our goal is to work on your behalf to minimize your out-of-pocket costs and efficiently meet all the requirements in your loan documents for your closing timeline. We do not pay referral fees to third parties; we earn our business by providing real value to each and every client.

Pricing

Third party fees are important, but they are a small portion of the overall defeasance costs. Thirty Capital Financial offers a fair and competitive flat fee for our comprehensive defeasance consulting services. Our proprietary ‘negotiated trade’ process ensures the lowest defeasance portfolio cost for every Borrower. We take great pride in our services and continue to invest in new technology and relationships to deliver our clients the best possible economics for their defeasance. Our proprietary pricing models, subscriptions to live trading data feeds and direct trader relationships are just a few ways we set ourselves apart from the competition.

 

Speak with one of our experts today to learn more about our defeasance services.

Interest rates are on the rise, a trend that is anticipated to continue through 2022 and well into 2023. In June 2022, the Federal Reserve, the nation’s central banking system, increased interest rates (for the second time in a row) by 75 basis points to a target range of 2.25% to 2.5%. 

When the Federal Reserve announces rate fluctuations, investors should pay attention. These changes often reflect the nation’s economic health and can therefore have a significant impact on interest rates for commercial real estate (CRE). With inflation and interest rates at an all-time high, CRE investors must keep an eye on today’s aggressive rates and consider the potential effects on their returns. Investors with diversified investment portfolios that include commercial real estate will benefit from the industry’s ability to hedge against inflation. 

 

Read ahead to learn about interest rate hedging in commercial real estate and how you can protect your assets in a continuously evolving (and unpredictable) market.

 

What Is Interest Rate Hedging and How Does It Relate to CRE?

Interest rate hedging is a means of reducing and controlling an investor’s exposure to risks in an ever changing market. Historically, commercial real estate is an asset used not only for portfolio diversification but also to hedge against inflation and minimize risks. Commercial real estate is often used for hedging because property values tend to increase along with inflation. Plus, property owners can increase rents to offset rising prices. 

 

What Do Higher Interest Rates Mean for CRE Investors?

Nearly all commercial real estate is purchased using some combination of debt and equity. Therefore, rising interest rates can dramatically impact the cost of commercial properties. In short, as the cost of capital rises, it becomes more expensive to own and invest in real estate.

Amidst rising rates, some investors fear that capitalization rates and operational costs will rise while property values decrease. In turn, this could mean that properties will produce lower returns. Factor in increasing borrowing costs and higher vacancy rates, and the potential impacts  of higher interest rates on investors are clear.

 

1) Higher Borrowing Costs

When interest rates are high, businesses are subject to higher borrowing costs. In turn, it eventually becomes more expensive for borrowers seeking CRE loans to construct, acquire, or refinance commercial property. Because of rising interest rates, it is also more expensive for banks to make large commercial loans. Consequently, borrowers may also encounter unfavorable terms due to higher loan costs. Thus, businesses seeking to expand or relocate potentially face challenges when attempting to secure financing for a commercial property. And with fewer transactions occurring, the outcome is often slower growth and fewer investments.

 

2) Higher Vacancy Rates and Increased Defaults

Rising interest rates can also lead to higher vacancy rates and decreased values of physical assets in commercial buildings. This low occupancy and risk for defaults may be attributed to tenants who may no longer be able to afford monthly rent payments. In today’s climate where 30% of renters have taken out a loan to help pay rent, landlords may have difficulty filling vacancies. In addition, high-interest rates can make it difficult for property owners to refinance their loans, leading to increased financial strain. 

Ultimately, high-interest rates can significantly impact both new development and existing commercial properties. For investors, high vacancy rates signal a risky investment that is likely to negatively affect cash flow and return on investment.

 

How Can CRE Investors Hedge Against Rising Interest Rates?

For investors worried about how economic shifts will impact their portfolios, CRE investments can be a great hedge against the effects of inflation and rising interest rates. Below are specific methods CRE investors can take to hedge against rising interest rates:

 

1) Consider an Interest Rate Cap

An interest rate cap is a limit on how high an interest rate can rise on variable rate debt. A higher cap rate means that the market judges the property to have more risk, which means that investors need to earn a higher rate of return. For investors, an interest rate cap guarantees investment risks are at a minimum, even in a fluctuating market.

 

2) Consider an Interest Rate Swap

An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another, over a set period of time. Interest rate swaps are one strategy CRE investors can use to establish reliable future cash flows regardless of future interest rate fluctuations. Because forward-thinking investors value risk mitigation (especially during uncertain times), interest rate swaps are a suitable means to minimize risks associated with macroeconomic conditions.   

 

3) Speak With An Advisor

An advisor, like Thirty Capital Financial, can provide you with tools and custom solutions for interest rate risk management by using strategies that consider your risk tolerance and the current market. Whether it’s risk on current floating-rate debt, refinance risk on fixed-rate debt, or risk on prepayment penalties, an experienced advisor can help you manage the interest rate risk associated with that debt through consultations and strategic portfolio planning.

 

Ready to confidently manage financial risk, navigate shifts in the industry, and assess exposure for your CRE portfolio? Contact us today to speak with an interest rate hedging expert!

The transition from LIBOR to SOFR affects commercial real estate because many CRE loans have LIBOR-based interest rates. With LIBOR tied to more than $350 trillion of contracts globally and nearly $200 trillion of US dollar contracts, this is one of the biggest and most significant events in the history of financial markets. And it’s important that your firm is prepared for this change.

Download the checklist to learn how to navigate the transition from LIBOR to SOFR with ease!