Fixed vs floating rate

Fixed versus floating is not a contest to find the prettier coupon on closing day.

It is a decision about which part of the loan gets to move.

Fix the rate and the payment becomes more predictable, while the exit may tighten through yield maintenance, defeasance, a declining prepayment schedule, or a lockout. Float the rate and the borrower may gain flexibility, while the index, cap cost, and payment remain exposed.

The property will carry one kind of tension. Choose the one the business plan can survive.

Put the full obligation on the table

A fixed-rate loan holds its stated rate for a defined period. Fannie Mae’s multifamily prepayment guidance is a useful reminder that a fixed coupon does not promise a free exit.

The scheduled payment may be predictable while the payoff is not. If the sale funds the projected return, an unmodeled prepayment charge is not a legal footnote. It is equity that never arrives.

A floating-rate loan usually charges an index plus a spread. The index may reset while the spread remains fixed, and a floor may stop the rate from falling below a minimum. Many commercial loans use SOFR or a SOFR-based rate. The New York Fed administers and explains SOFR; the loan documents specify which version, observation period, reset timing, and conventions apply.

Do not compare a fixed coupon with today’s floating coupon and announce a winner. Compare these across the entire business plan:

• scheduled principal and interest;
• interest-only period and amortization afterward;
• index, spread, floor, and reset mechanics;
• cap strike, term, notional, provider, and replacement requirement;
• extension fees and conditions;
• prepayment cost on the expected sale or refinance date; and
• covenants and cash-management triggers under stressed payments.

The OCC’s Commercial Real Estate Lending handbook tells bank examiners to consider fixed versus variable pricing, index exposure, sensitivity analysis, and stress testing. Equity should not be less curious than the regulator examining its lender.

Two points moves $200,000

Consider a hypothetical $10 million floating-rate, interest-only loan priced at one-month SOFR plus a 2.50% spread. Assume SOFR is 3.50% at closing, so the all-in rate is 6.00%.

Annual interest starts at $600,000. If property NOI is $1.20 million, debt-service coverage is 2.00x.

Now move SOFR to 5.50%. The all-in rate becomes 8.00%, annual interest becomes $800,000, and DSCR falls to 1.50x. The property did not lose a tenant. Expenses did not spike. Two hundred thousand dollars of annual cash flow moved from ownership to the lender because the index moved.

Suppose the loan requires a cap with a 5.00% SOFR strike. Above that strike, the cap provider should make contractual payments that offset covered index exposure, subject to the actual confirmation. At 5.50% SOFR, the protected all-in economics would be roughly 7.50%, or $750,000 a year, before timing differences and document details.

The cap helped. It did not turn floating debt into 6.00% fixed debt.

Fannie Mae’s interest-rate cap guidance ties cap strike analysis to required debt-service coverage and can require a reserve for replacement coverage when the cap expires before the loan. Replacement protection can become painfully expensive when volatility and rates rise while the property is already under pressure.

Protection can end before the loan

The clean pitch shows the cap strike. The serious review marks the cap expiration.

A three-year loan with a one-year extension does not have four protected years merely because the model expects a month-30 sale. Read the cap confirmation, cap agreement, assignment, and lender requirements. Verify:

• covered index and strike rate;
• effective date and expiration date;
• notional amount and whether it steps down;
• payment dates and calculation agent;
• provider and required credit rating;
• collateral, assignment, and lender remedies;
• replacement deadline, escrow, and required term; and
• whether an extension requires a new cap at a different strike.

Then read the note and loan agreement for the index definition, spread, floor, default rate, day-count convention, reset date, interest-only expiration, amortization schedule, maturity, extension tests, minimum DSCR, debt-yield covenant, cash sweep, and recourse carveouts.

The term sheet is the lender describing the rope. The executed documents show where it is fastened.

For fixed debt, add the prepayment rider, yield-maintenance formula, defeasance provisions, lockout, and open period. Obtain a written payoff estimate at the modeled exit date. A low fixed rate can still pin equity in place if the plan needs to sell while the prepayment bill is high.

Ask which error the structure tolerates

• What is the monthly payment today, at the cap strike, and after interest-only expires?
• What NOI produces the minimum covenant coverage in each case?
• When does the cap expire relative to maturity and every extension option?
• How much is reserved for a replacement cap, and when was that cost last quoted?
• What does prepayment cost on the base-case exit date and one year earlier?
• Can the lender sweep cash even when the loan is current?
• What happens if the renovation is six months late and the index is 2% higher?
• Is the refinance underwritten to a stressed rate, amortization, and value, or to hope?

Fixed debt generally trades flexibility for certainty. Floating debt generally trades certainty for flexibility and exposure. Neither is morally better. One may simply be better matched to this property’s income, timeline, and exit.

Write the survival card

On one page, list the current payment, maximum protected payment, payment after interest-only, covenant threshold, cap expiration, maturity, extension conditions, and prepayment cost at the intended exit. Put the source document and section beside every number.

Any blank is an unsecured part of the plan. Fill it before deciding which rate structure holds.