SOFR & Credit Spreads

The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate published by the Federal Reserve Bank of New York, based on actual overnight transactions in the Treasury repurchase (repo) market — where cash is lent overnight against Treasury securities as collateral. SOFR replaced LIBOR as the standard U.S. dollar floating-rate benchmark after regulators determined LIBOR's reliance on bank estimates, rather than observable transactions, made it vulnerable to manipulation and unreliable as trading volume in the underlying interbank market declined.

Floating-rate CRE loans — bridge loans, construction loans, and many bank and debt fund loans — are now typically indexed to Term SOFR (a forward-looking rate for a set period, such as 30 days) or to daily compounded SOFR, rather than to a fixed rate.

A floating-rate loan's all-in rate is built the same way a fixed-rate loan is, just with a different base: SOFR plus a spread. The spread is where the lender's assessment of deal-specific risk shows up — property type and business plan (stabilized versus transitional), leverage, sponsor experience and balance sheet, and whether the loan is recourse or non-recourse. A lower-risk, well-leveraged stabilized asset with an experienced sponsor generally commands a tighter spread than a heavily leveraged, transitional asset with a first-time sponsor.

SOFR reflects the broad cost of short-term secured borrowing, but the spread reflects credit risk and capital markets conditions — and those two things don't always move together. In a credit-tightening environment, lenders often pull back their risk appetite, warehouse and CLO funding costs for debt funds can rise, and fewer lenders competing for deals means less pressure to tighten pricing. All of this can push spreads wider even if the central bank hasn't moved the policy rate and SOFR itself is unchanged. This is why floating-rate borrowers can see their quoted pricing move even during periods when the base rate looks stable.

Because the index component of a floating rate can rise during the loan term, many floating-rate CRE loans — especially bridge and construction loans — require the borrower to purchase a rate cap, which caps the index at a specified strike rate for a fee, protecting the borrower's debt service (and the lender's DSCR covenant) from a spike in SOFR. A rate cap only protects against the index moving; it does nothing to protect against the spread widening at refinancing or maturity.