SOFR

Definition

SOFR stands for the Secured Overnight Financing Rate. It is a widely used U.S. benchmark interest rate derived from activity in the U.S. Treasury repurchase (repo) market. In real estate finance, SOFR often serves as the reference rate for floating-rate loans.

How SOFR Shows Up in Loan Pricing

Many floating-rate loans are priced as:

• All-in rate = SOFR + spread

The spread is the lender’s margin (compensation for credit risk, costs, and profit). As SOFR moves up or down, the borrower’s interest rate and payment generally move with it.

Why SOFR Matters to Investors

• Cash flow volatility: rising SOFR increases debt service, reducing cash flow.
• DSCR pressure: higher payments can reduce DSCR and trigger covenants or cash management.
• Refinance risk: if SOFR is high when you need to refinance, permanent financing proceeds may be lower.
• Hedging decisions: floating-rate borrowers often use an interest rate cap to limit exposure.

SOFR vs. Fixed Rates (Conceptual)

• Floating-rate (SOFR-based): more flexible for transitional business plans, but exposed to rate increases.
• Fixed-rate: more stable payments, but sometimes less flexible and may include prepayment penalties.

SOFR + Spread + “Floor”

Some loans include a SOFR floor, meaning the reference rate cannot go below a minimum (for example, 0.50%). Floors protect lenders in low-rate environments. In a floor structure:

• All-in rate = max(SOFR, floor) + spread

Example

A bridge loan is priced at SOFR + 3.25%. If SOFR is 4.80%, the all-in rate is:

• All-in rate = 4.80% + 3.25% = 8.05%

If SOFR rises to 5.80%, the all-in rate becomes 9.05%, increasing debt service and reducing cash flow.

Common Pitfalls

• Underestimating rate sensitivity: small rate changes can materially impact DSCR and refinance proceeds.
• Ignoring cap costs: interest rate caps can be expensive when volatility is high—budget for them.
• Confusing spread vs. reference rate: SOFR moves; the spread is typically fixed in the loan terms.
• Not modeling floors: floors matter when rates are low and can raise the effective borrowing cost.

Related Terms

• Floating-rate loan
• Interest rate cap
• Refinance risk
• Debt service
• Debt service coverage ratio (DSCR)
• Fixed-rate loan
• Rate lock

Note: This glossary entry is for education only and is not financial, legal, or investment advice. Loan terms and benchmarks vary by lender and document; always review your loan agreement and consult professionals.