A view on rates is only half of it. The break-even tells you which view you are taking, and the sizing test tells you how much each structure will lend.
A floating-rate commercial mortgage is cheaper than a fixed one only if SOFR averages below a break-even level: the fixed rate, less the floating spread, less the yearly cost of the rate cap the lender requires. On an illustrative $25.0M five-year loan at 6.25 per cent fixed against SOFR plus 2.25 per cent with a $250,000 cap, the break-even is an average SOFR of 3.80 per cent. At a flat 4.30 per cent, floating costs $625,000 more over five years; on a falling path it saves $425,000. And the floating loan is sized at a stressed rate, so the same property supports $4,237,241 less of it.
Worked in full in Real Estate Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The choice is usually framed as a view on rates. It is three separate calculations: the cost under the rate paths you think plausible, the break-even that tells you which view you are actually taking, and the loan amount each structure supports.
| Input | Value |
|---|---|
| Loan | $25,000,000 |
| Fixed rate | 6.25% |
| Floating rate | SOFR + 2.25% |
| Required rate cap | 5.00% strike, 3 years, $250,000 upfront |
| Property NOI | $2,400,000 |
| Minimum DSCR for sizing | 1.25x |
Break-even average SOFR = fixed rate − spread − cap cost ÷ (loan × years)
6.25% − 2.25% = 4.00% before the cap. Spreading the $250,000 cap over five years on $25,000,000 costs 0.20% a year, so the break-even is 3.80%. This holds while SOFR stays below the 5.00% strike, so the cap pays nothing. In Excel: =B2-B3-B4/(B1*B5).
The fixed loan costs $1,562,500 a year, $7,812,500 over five years. A floating borrower pays less only if SOFR averages below 3.80 per cent over the same five years. With SOFR at 4.30 per cent at closing, the floating rate starts at 6.55 per cent, above the fixed rate: on these terms, choosing floating is a bet that rates fall by at least half a point on average.
| Path | Y1 | Y2 | Y3 | Y4 | Y5 | Average | Floating total, $ | vs fixed, $ |
|---|---|---|---|---|---|---|---|---|
| Flat | 4.30% | 4.30% | 4.30% | 4.30% | 4.30% | 4.30% | 8,437,500 | 625,000 |
| Falling | 4.30% | 3.75% | 3.25% | 3.00% | 3.00% | 3.46% | 7,387,500 | −425,000 |
| Rising | 4.30% | 5.00% | 5.75% | 6.00% | 6.00% | 5.41% | 9,637,500 | 1,825,000 |
On the rising path the cap does its job in year 3, holding the all-in rate at 7.25 per cent when SOFR reaches 5.75 per cent. It then expires: years 4 and 5 run at 8.25 per cent, $2,062,500 a year against $1,562,500 fixed. The asymmetry is the point. The falling path, a fall of 1.30 points, saves $425,000; a rise of 1.70 points costs $1,825,000, because the floating loan starts above the fixed rate and the protection runs out before the loan does.
| Flat SOFR | Floating total, $ | vs fixed, $ |
|---|---|---|
| 3.00% | 6,812,500 | −1,000,000 |
| 3.50% | 7,437,500 | −375,000 |
| 3.80% | 7,812,500 | 0 |
| 4.30% | 8,437,500 | 625,000 |
| 5.00% | 9,312,500 | 1,500,000 |
The break-even turns the decision into a question you can test against your own view. If you expect SOFR to average 3.50 per cent, floating saves $375,000 over the term; if you expect 4.30 per cent, fixed saves $625,000. If you have no view, the forward curve built into the cap price is the market's, and paying for a floating loan that only wins on a below-forward path is a speculative position, not a financing decision. Borrowers whose business plan needs predictable debt service, a long hold with thin coverage, should treat the fixed premium as insurance and judge it as such.
Lenders usually size a floating loan at the capped rate, strike plus spread, not at today's rate. At a 1.25x DSCR the property can carry $1,920,000 of interest a year.
| Structure | Sizing rate | Maximum loan, $ |
|---|---|---|
| Fixed | 6.25% | 30,720,000 |
| Floating, sized at strike + spread | 7.25% | 26,482,759 |
| Difference | 4,237,241 |
The floating structure supports 13.8 per cent less debt. On the $25,000,000 loan both pass, at 1.54x fixed and 1.32x on the stressed floating rate, but a borrower who needs more than $26.5M has no floating option at this strike without buying a lower, more expensive cap. The sizing effect of rates is worked in more detail in how much higher interest rates cut a commercial loan.
Comparing today's floating rate with the fixed rate and stopping there. The relevant comparison is the break-even average over the whole term, after the cap premium, set against the paths you find plausible, plus the loan amount each structure delivers. A second error is to treat the cap as if it covered the loan: here it covers three of five years, and the rising path's damage is done after it expires. What floating does buy, and the numbers above leave out, is prepayment flexibility: a fixed loan is usually prepayable only with yield maintenance or defeasance, which matters if the business plan is a sale in year 2 or 3.
SOFR paths, spreads and cap prices are illustrative, not forecasts or market quotes; the totals are undiscounted. Not advice on any financing.
The binding sizing test is one of the four workbooks on the companion page for this book. The prepayment cost that floating avoids is worked in how to calculate yield maintenance.
Subtract the floating spread and the yearly cost of any required cap from the fixed rate. With 6.25 per cent fixed, a 2.25 per cent spread and a $250,000 cap spread over five years on $25,000,000 (0.20 per cent a year), floating is cheaper only if SOFR averages below 3.80 per cent.
Because they size it at a stressed rate, typically the cap strike plus the spread. At 5.00 per cent plus 2.25 per cent, $1,920,000 of debt service capacity supports $26,482,759, against $30,720,000 at a 6.25 per cent fixed rate: 13.8 per cent less.
Only while it lasts. A three-year cap at 5.00 per cent holds the rate at 7.25 per cent in year 3 of the rising path, but in years 4 and 5 the loan pays 8.25 per cent, $2,062,500 a year against $1,562,500 fixed.
This article is one calculation from Real Estate Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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