Navigating SOFR: Floating Rate Loans and Hedging in CRE

By Majid Radaei, RadCRE · 2026-03-25 · Market Updates

Amidst persistent interest rate volatility, the shift to SOFR has reshaped CRE financing. Bridge loans at SOFR + 300-600 bps are common, with hedging costs soaring as volatility continues to impact deal viability.

SOFR Transition Continues to Redefine CRE Lending Landscape

The transition from LIBOR to the Secured Overnight Financing Rate (SOFR) as the benchmark for floating rate commercial real estate loans has fundamentally altered financing structures and risk management strategies. As of Q1 2026, market participants are acutely focused on managing SOFR volatility, which continues to impact debt service coverage ratios and the overall viability of new acquisitions and refinancings.

Lenders, including major institutions like JPMorgan Chase and Wells Fargo, have fully embraced SOFR, with nearly all new floating-rate originations tied to the benchmark. This shift has not been without its challenges. Borrowers are contending with a SOFR rate currently hovering around 4.31%, making the all-in cost of capital for bridge loans, which often price at SOFR + 300-600 basis points, significantly higher than in previous cycles. This translates to an effective interest rate of 7.31% to 10.31% for many transitional assets.

Hedging Strategies Evolve Amidst Rate Uncertainty

Mandatory hedging requirements, predominantly interest rate caps or swaps, remain a crucial component of floating-rate loan covenants. However, the cost of these hedges has escalated dramatically. For instance, a common interest rate cap with a strike rate of 5.00% to 6.00% that might have cost 50-100 basis points of the loan amount two years ago can now command 150-300 basis points or more, particularly for longer tenors (e.g., 3-5 years). This increased cost directly impacts cash available for equity returns and can strain deal proformas.

Many borrowers are exploring shorter-term caps or collars to mitigate upfront costs, although this exposes them to renewed hedging expense at renewal. Some sophisticated sponsors are also leveraging forward starting swaps or swaptions to lock in future rates, though these instruments carry their own complexities and are typically reserved for larger, institutional transactions. The market for these instruments has seen increased activity, with firms like Chatham Financial reporting a surge in demand for bespoke hedging solutions.

Lender Underwriting Focus on Debt Service and Exit Strategy

In this environment, lenders are placing an even greater emphasis on debt service coverage ratios (DSCRs) and clear exit strategies. Underwriting models are oftenStress testing at rates 150-200 bps above the current SOFR to ensure resilience. For example, a multifamily bridge loan might require a minimum DSCR of 1.15x-1.20x at the stressed rate, compelling borrowers to bring more equity to transactions or seek properties with stronger in-place cash flows.

The lending community's caution is evident in reduced leverage points across many asset classes. Where a few years ago loan-to-cost (LTC) ratios of 70-75% were common for value-add plays, today 60-65% LTC is more typical for bridge financing on similar assets. This trend is further exacerbated for development financing, where construction loan spreads have widened to SOFR + 250-400 bps, coupled with lower leverage and more stringent equity requirements.

RadCRE Perspective

"The SOFR transition isn't just about a new index; it's about a complete re-evaluation of interest rate risk for CRE investors. Many borrowers were caught off guard by the rapid rise in SOFR and, critically, the prohibitive cost of hedging. We're seeing situations where the cap premium alone can eat into 25-30% of the sponsor's initial cash equity. This isn't sustainable for many value-add business plans.

At RadCRE, we’re advising clients to be incredibly granular in their proformas. Don't just budget for SOFR + spread; model out the cap cost explicitly and understand how it impacts your unlevered yield and equity multiple. For hotel acquisitions, where cash flows can be more volatile, this is especially critical. We are often structuring capital stacks that incorporate preferred equity alongside senior debt to reduce the senior loan amount and thereby lower the required cap notional, or exploring options like shorter-term debt with robust re-hedging analysis built into the financial model. For certain institutional clients, considering fixed-rate CMBS (with spreads around T + 150-300 bps for stabilized assets) might be more appealing, despite higher prepayment penalties, if they prioritize predictable debt service. The key is to be proactive and sophisticated in your debt structuring, not reactive." – Majid Radaei, Founder of RAD Commercial Realty

The market also continues to grapple with the availability of hedging providers. While larger banks are active, smaller regional banks may have limitations on the size and complexity of derivatives they can offer, sometimes forcing borrowers to seek hedge providers independently from their loan originators.

Tags: commercial real estate financing, SOFR, floating rate loans, interest rate hedging, bridge lending, CMBS spreads, CRE capital markets, RadCRE

Sources: CoStar, Commercial Observer, GlobeSt, Chatham Financial, Mortgage Bankers Association (MBA)