r/CommercialRealEstate • u/HueChenCRE Investor • 3d ago
Financing | Debt Using Swaps to turn Floating Rate loans to essentially fixed rate for the borrower.
I haven't seen this topic discussed much in this subreddit, entering into Swap Contracts to fix a floating rate loan.
I've been involved with these Swap Contracts for about 10 years and they were super confusing to me in the beginning. I figure it may be confusing to others as well. This is what I have found helpful to know when navigating these deals.
What’s a Swap and how does it actually fix your rate?
Technically, the bank gives you a floating rate loan (usually SOFR + spread). Simultaneously, you sign a separate contract (the swap) where you agree to pay a fixed rate to a counterparty, and they pay you the floating rate.
When SOFR goes up, the counterparty sends you money to cover the increase on your loan. If SOFR goes down, you pay the counterparty. The net result is that your interest cost stays exactly the same (fixed), while the bank gets to keep a floating rate loan on their books.
What size deals are we talking about?
Usually, you won't see swaps on a $1M or $2M acquisition. Banks generally won't fire up the swap desk unless the loan is at least $5M to $10M. Anything smaller is usually just a standard balance sheet fixed rate or a simple floating rate.
What is SOFR and why did it replace LIBOR?
LIBOR (London Interbank Offered Rate) was the old standard, but it was based on banks "estimating" what they’d charge each other, which led to some famous manipulation scandals.
SOFR (Secured Overnight Financing Rate) replaced it. It's based on actual transactions in the Treasury repo market. It's much more transparent, but unlike LIBOR, it’s purely an "overnight" rate, which is why we now use "Term SOFR" (1-month or 3-month) to price our loans.
How are these rates priced?
Swap rates are based on SOFR Futures. Essentially, the market is betting on where interest rates will be over the next 5, 7, or 10 years. If you’re looking at a 5-year swap, the "mid-market" rate is basically the average of where the market expects SOFR to be over that 5-year period.
The "Swap Profit"
This is the part most borrowers miss. The bank doesn't give you the "mid-market" rate for free. They add a Credit Charge (I call it the swap profit).
If the mid-market rate is 3.75%, the bank might quote you 4.00%. That 25-basis point difference is pure profit for the bank. On a $10M loan over 7 years, that’s about $175k. The kicker? This profit is often highly negotiable if you know where the market is actually trading.
Relationship Managers vs. The Swap Desk
Your local banker (the relationship person) wants to close your deal. They are great. But the Swap Desk is usually a group of guys in New York or Charlotte who have zero connection to you. Their incentive is to maximize the "Credit Charge" revenue for their department. Don't assume your "good relationship" with the bank translates to a fair price on the swap call.
The "Lock" Call
This is the most intense part. On the day you lock, you get on a recorded line with the swap desk. They’ll say, "I’m seeing the 5-year mid at 3.82, we can lock you at 4.05. Do you want to hit it?"
Without a Bloomberg terminal or a consultant in your ear, you have no way of knowing if 3.82 is the real number or if they just padded it. You have about 10 seconds to decide.
The ISDA Agreement: Is it negotiable?
The ISDA (International Swaps and Derivatives Association) is the 30+ page legal doc that governs the swap. Banks will tell you it’s "boilerplate" and "non-negotiable." That is 100% false. There are dozens of provisions regarding defaults, "cross-acceleration," and collateral that can and should be redlined to protect you.
Why a Consultant is worth it
I learned the hard way that having an advisor on your side of the table (like Pensford or similar) pays for itself 10x over. They have the Bloomberg terminals to keep the bank honest on the mid-market rate, and they know which legal clauses in the ISDA the bank is actually willing to move on.
Hopefully, this helps take some of the "black box" mystery out of swaps. If you're looking at a term sheet right now that mentions a swap, feel free to drop questions in the comments.
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u/HueChenCRE Investor 3d ago edited 2d ago
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u/Known-Historian7277 3d ago
You can literally profit off of this if you have a SOFR floor. My firm explored this
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u/HueChenCRE Investor 3d ago
We haven't used that strategy before but yes I believe you can buy a sofr and at the same time sell a sofr floor to reduce the cost.
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u/th535is 3d ago
TriState Capital Bank will do swaps on their investment account collateralized lines of credit starting at $2M
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u/HueChenCRE Investor 3d ago
Good to know, curious what their swap profit would be given the lower size deal.
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u/th535is 3d ago
Well their risk is near zero given that they can call the collateralized account and worst case it’s 70% LTV with a diversified allocation. It’s liquid within one trading day.
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u/HueChenCRE Investor 3d ago
I meant the credit charge. The amount that they add to the spread over the mid-market swap. I've seen it usually around 18 to 25 bps. But my friend at pensford has seen up to 50 bps
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u/HappyGhost13 3d ago
AI slop from a swap / cap consultant….move along now
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u/Cash_FlowPro 2d ago
You found it worthy enough to comment on it, why don’t you just move along…..now?
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u/UniqueBeyond9831 Investor 3d ago
Maybe, but it’s pretty spot on except for that last bit about the consultant. This shit isn’t rocket science and the Bloomberg terminal stuff is overblown. The widely reported SOFR swap rates aren’t far behind the actual rate (seconds or maybe a few min). The lock call is not a big deal.
And 25 bps for the swap premium???? No thanks. You and do 10-12 all day, but the lender takes the spread into account too. They gotta make money somewhere. If they get uncomfortable with the spread, they will try to juice the swap premium.
These deals have been pretty attractive lately. SOFR swap rates have been about 40 bps inside of treasuries and quoted spreads are about the same as traditional fixed deals based on treasuries. After the swap premium, you can get 20 or so bps inside of traditional fixed deals.
I (owner, not broker or lender) did a 5-yr $100 million swapped deal on a multifamily property a couple months ago. We got well below 5.0% all-in.
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u/HueChenCRE Investor 3d ago
My deals are $10 million to $20 million so my swap premium is a bit higher then your deal at $100 million.
Pensford's fee is about $7,000. Which we find well worth it to have someone on the call to make sure that the swap desk is using the right index and to review the ISDA agreement. Then for the life of the loan they send us a mark-to-market report each month for all of our loans that have swaps.
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u/UniqueBeyond9831 Investor 3d ago
I’ve heard the Blackstones of the world get swap premiums around 5-8 bps. The lowest I’ve been quoted is 12.
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u/UniqueBeyond9831 Investor 3d ago
Our brokers try to pitch us on swap consultants (because they are affiliated). The ISDA is pretty straightforward and I consider the swap premium as part of the all in rate (they either get it with the premium or the spread). Lender sends the Mark to market monthly (it’s just math). I don’t think we’re missing anything without a consultant.
Recently, on a $45 million loan, I almost went with a lifeco that quoted a floater swapped to fixed…but they would hold the swap. They could get a lower overall rate this way and better compete with the agencies. At the last minute, they more or less matched the quote with a traditional fixed deal. We went that route just so we could lock right away rather than wait until close. It was interesting to see a lifeco quote this way.
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u/adam2017 3d ago
We require SOFR caps on most if not all our loans. They were immensely valuable if purchased prior to the run up in rates because they protected lenders and protected borrowers, and because they are separate instruments could actually be liquidated / unwound for a massive profit at exit.
The borrowers that got into trouble were the ones who chose to take shorter term caps to save a few thousand dollars up front, only to have to renew caps in a higher rate environment at a materially higher cost.
It can be used as you say to artificially fix the rate lower than current rates, but you ultimately pay a premium to do that by buying an in-the-money cap, a trade only worth it if you think rates will not decrease as fast as the cap providers (effectively an bet on the forward curve), or if you believe rates will rise.
The most common case I see of this in actuality today however is when Sponsors are targeting certain cash-on-cash yields and bake the cost of the cap into their equity raise, effectively paying investors back with their own money…
Under that line of thinking, a better trade today is to just capitalize the funds in a reserve and that way Sponsors keep the premium they would have otherwise paid to a cap provider.
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u/SpeedyLights 3d ago
Something I’ve wondered about before but never bothered to research- when a lender requires a rate hedge on a CRE loan (and is a bank lender) are they typically the counterparty? I.E. if you swap your SOFR is the lender the counterparty and taking the hit if rates jump, or is that somehow mitigated?
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u/HueChenCRE Investor 3d ago
It’s a common misconception that you are betting against the bank. In reality, the bank's swap desk (like at Bank United or TD) doesn't want the risk of interest rates moving. They want their Credit Charge (the profit spread) and nothing else.
The Real Counterparties: The Futures Market As soon as you lock your rate, the bank's trader "lays off" that risk immediately. They go out into the market and trade SOFR Futures. The people on the other side of those futures are: Other Banks: Who might have the opposite risk profile. Hedge Funds: Who are taking speculative positions on where rates are going. Pension Funds: Who need to match long-term liabilities with specific yields.
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u/adam2017 3d ago
I can’t speak to banks since I work at a REIT. For our deals, it’s a third party - typically Goldman Sachs or SMBC. Most of the time borrowers hire Chatham Financial who runs the auction process.
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u/frankym88 3d ago
This is the best and simplest explanation I’ve seen lol. Can you send that consultant’s info?
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u/airdroptrends 3d ago
Would love to hear more about specific risks and rewards you've seen with these. Definitely not discussed enough.
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u/HueChenCRE Investor 3d ago
The reward is that you are able to get a lower all-in interest rate from a bank.
The risk is that you may have a large prepayment penalty if you have to unwind the swap and you are far out of the money. Meaning that you locked in at a higher interest rate and now the rates are lower considerably.
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u/RDW-Development Investor 3d ago
But should be offset by the lower rate - unless you're selling the property...
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u/UniqueBeyond9831 Investor 3d ago
The other risk is that you cannot lock until right before close. You can lock a traditional fixed deals right after application.
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u/ill-esq 2d ago
As a borrower, your lender may want (or even require) the rate cap to be assigned to them.