SOFR: Secured Overnight Financing Rate
SOFR, or the secured overnight financing rate, is a rate tied to the cost of interbank Treasury repurchases. The rate has begun to replace LIBOR, or the London interbank offered rate, for pricing variable-interest loans.
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Check the table below to find your relevant SOFR index rate. These rates are updated daily.
What Is SOFR?
SOFR, or the secured overnight financing rate, is a rate tied to the cost of interbank Treasury repurchases. The rate has begun to replace LIBOR, or the London interbank offered rate, for pricing variable-interest loans.
Created by the Federal Reserve and first published in April 2018, SOFR is replacing LIBOR via a gradual phase-in period which began Jan. 1, 2022, and will end June 30, 2023. The push for this replacement comes from several major scandals in recent years associated with LIBOR manipulation.
The transition from LIBOR to SOFR will not occur overnight, even though the one-week and two-month LIBOR ceased publication at the end of 2021. The rate’s other variations (overnight, one-month, three-month, six-month and 12-month) will continue publication through June 2023.
How Is SOFR Calculated?
One of the main differences with SOFR's use stems from its basis on completed transactions — rather than LIBOR’s reliance on self-reported quotes from financial institutions. As a result, the rate is far less susceptible to manipulation and based on historical activity. LIBOR had come under fire in recent years, particularly after a number of major banks were implicated colluding to push the rate higher (and lower) by submitting artificial interest rates.
Another key component of SOFR calculations is the use of a significantly larger data set than LIBOR. The secured overnight financing rate is calculated using Treasury repurchases, which average between $2 and $4 trillion in volume on a daily basis, according to a 2020 report from The Brookings Institution.
One other major difference between the two rates is that with SOFR there is no credit risk premium included in its calculation, as it’s a secured rate. Many analysts anticipate loan rates will include a credit spread to account for this change.
Impact on Real Estate Debt
In late 2021, the Fed estimated contracts valued at more than $200 trillion were tied to LIBOR worldwide. So, if you have a variable-rate loan based on LIBOR maturing after June 2023, what then?
Many loans include fallback language, which give lenders some flexibility in determining how to transition from LIBOR. A large number of loans will shift to a comparable SOFR automatically. If this clause isn’t in your mortgage, your lender may request an amendment to the document to clarify the transition. While SOFR is becoming the benchmark rate, it is not required under law — and, as a result, a number of other credit-sensitive rates have been created, even though they have gained nowhere near SOFR’s traction.
As there are multiple possible scenarios, you should consider contacting your lender to discuss your specific financing packages if a transition plan is not clearly stated.
Related Questions
What is the Secured Overnight Financing Rate (SOFR)?
The Secured Overnight Financing Rate (SOFR) is a rate tied to the cost of interbank Treasury repurchases. It was created by the Federal Reserve and first published in April 2018, and is set to replace LIBOR (the London interbank offered rate) via a gradual phase-in period which began Jan. 1, 2022, and will end June 30, 2023. SOFR measures the overnight trading rate for the repurchases (repos) of U.S. treasury bonds, and is seen as a more stable source of market interest-rate information than LIBOR.
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How does SOFR affect commercial real estate financing?
SOFR is set to replace LIBOR by 2021, and this could have a significant impact on commercial real estate financing. Many loans include fallback language, which give lenders some flexibility in determining how to transition from LIBOR. A large number of loans will shift to a comparable SOFR automatically. If this clause isn’t in your mortgage, your lender may request an amendment to the document to clarify the transition.
It is important to note that while SOFR is becoming the benchmark rate, it is not required under law — and, as a result, a number of other credit-sensitive rates have been created, even though they have gained nowhere near SOFR’s traction. As there are multiple possible scenarios, you should consider contacting your lender to discuss your specific financing packages if a transition plan is not clearly stated.
In most cases, if SOFR is not widely adopted due to inaccuracies found during calculations of SOFR during the last 12 months, most adjustable commercial real estate loans have a built-in switch mechanism that will kick in if LIBOR is no longer calculated. In most cases, this will result in the loan being pegged to a spread based on the prime rate, the lowest bank interest rate available to consumers.
What are the advantages of using SOFR for commercial real estate financing?
The main advantage of using SOFR for commercial real estate financing is that it is a more reliable index than LIBOR. SOFR is based on the overnight trading rate for the repurchases (repos) of U.S. treasury bonds, which is unlikely to stop anytime soon. This makes it a more stable source of market interest-rate information than LIBOR, which measures interbank lending. Additionally, SOFR is not easily subject to manipulation, unlike LIBOR.
What are the risks associated with SOFR for commercial real estate financing?
The main risk associated with SOFR for commercial real estate financing is the potential for inaccuracies in the calculations of SOFR during the last 12 months. This could lead to a lack of adoption of SOFR, which could result in most adjustable commercial real estate loans automatically switching to a spread based on the prime rate. This could lead to a variety of issues and inconsistencies.
Additionally, if a transition plan from LIBOR to SOFR is not clearly stated in your mortgage, your lender may request an amendment to the document to clarify the transition. As there are multiple possible scenarios, you should consider contacting your lender to discuss your specific financing packages.
How does SOFR compare to other financing rates?
SOFR is becoming the benchmark rate for financing, as it is far less susceptible to manipulation than LIBOR and is calculated using a significantly larger data set. SOFR is a secured rate, meaning it does not include a credit risk premium in its calculation, while other credit-sensitive rates may include one. If you have a variable-rate loan based on LIBOR maturing after June 2023, you should consider contacting your lender to discuss your specific financing packages if a transition plan is not clearly stated.
Source: www.commercialrealestate.loans/commercial-real-estate-glossary/sofr-secured-overnight-financing-rate and https://www.brookings.edu/blog/up-front/2020/01/28/what-is-the-repo-market-and-why-does-it-matter/
What are the implications of SOFR for small business financing?
The implications of SOFR for small business financing depend on the type of loan. If the loan is a variable-rate loan based on LIBOR maturing after June 2023, the loan may shift to a comparable SOFR automatically if the loan includes fallback language. If the loan does not include fallback language, the lender may request an amendment to the document to clarify the transition. In addition, other credit-sensitive rates have been created, though they have not gained as much traction as SOFR. It is recommended to contact the lender to discuss the specific financing packages if a transition plan is not clearly stated.
For fixed-rate loans, such as CMBS loans, HUD/FHA multifamily loans, and life company loans, the transition to SOFR should not affect them as much, unless the disruption caused by it were to actually cause a major fluctuation in interest rates themselves, which isn’t particularly likely.