The Independency of Rate Caps: Another Asset Class Altogether

A rate cap is paying an amount of money up front to limit the maximum amount the index rate (usually SOFR) can go on a floating rate loan. The spread (gross profit the lender gets) is added onto this rate.

For example: you pay $1,000,000 to have 2% be the highest rate the index can go. This is called a "strike rate." Say the lender's spread is 3%. The maximum interest rate during the duration of the rate cap term would be 5%.

So why is a rate cap independent where the loan is tied to the property? The rate cap is a derivative and is a separate asset altogether. This derivative can be traded or sold at any time, permitting the loan agreement doesn't require a rate cap.

When an asset is sold, the rate cap is not included in the sale unless otherwise negotiated. This is the case even on a loan assumption. The seller of the property who is also the owner of the rate cap can sell the rate cap in the open market if it's not negotiated into the sale.