A fixed-rate loan and a floating-rate loan on the same building are not two prices for the same thing. They are two different decisions about who carries the risk that money gets more expensive.
Sponsors tend to present the choice as a rate. Read it instead as a set of trade-offs, because the rate on day one is the least important line on the term sheet.
The Two Structures Side by Side
A fixed-rate loan locks the interest rate for the full term, commonly five, seven, or ten years. A floating-rate loan resets, usually monthly, to a published benchmark such as SOFR (the Secured Overnight Financing Rate) plus a spread the lender sets at closing. That single difference drives everything in the table below.
| Fixed-rate | Floating-rate | |
|---|---|---|
| Rate certainty | Payment is known to the dollar for the whole term | Payment changes with the benchmark; only the spread is fixed |
| Prepayment | Usually penalised: yield maintenance, defeasance, or a step-down schedule | Usually open after a short lockout, often with a modest exit fee |
| Caps and hedges | Not needed; the rate is the hedge | Lender typically requires a purchased rate cap; the cap has a strike, a term, and an upfront cost |
| Maturity | Longer terms available; refinance date is far out | Shorter terms, often two to three years plus paid extensions that carry conditions |
| Who bears the risk | The lender, if rates rise; the borrower gives up the benefit if they fall | The borrower, up to the cap strike; the cap seller above it, until the cap expires |
Two rows deserve a second look. The prepayment row is why fixed-rate borrowers who want to sell early can find the exit expensive: yield maintenance compensates the lender for the interest it would have earned, and on a $3,000,000 loan with years to run that can be a six-figure sum. The cap row is why floating-rate borrowers are not as exposed as they look, and also why they are more exposed than they say: a cap bought for two years protects nothing in year three.
When a Fixed Rate Makes Sense
Fixed debt suits a building the sponsor intends to hold and operate rather than flip. If the plan is to buy an older Southern California property with tenants in place, renovate units as they turn over, and collect rent for years, the value of knowing the payment outweighs the value of a cheaper exit. Cash flow projections mean more when the largest expense line cannot move.
It also suits investors who are in the deal for income rather than a quick resale. A fixed payment on a lightly levered building is the closest thing in private real estate to a predictable number. For a firm that already keeps sub-50% loan-to-value on every property, fixing the rate removes the second of the two variables that can turn a good building into a distressed one.
The price of that certainty is flexibility. If rates fall, the borrower keeps paying the old rate. If a buyer appears in year three with a strong offer, the prepayment penalty comes off the top of the proceeds. A sponsor choosing fixed debt should be able to tell you they have priced both of those outcomes and accepted them.
When a Floating Rate Makes Sense
Floating debt fits a short, defined business plan. A sponsor buying a mismanaged 16-unit property, spending 18 months on renovations and re-leasing, then selling or refinancing into permanent debt has a real use for a loan that can be repaid without penalty. Paying yield maintenance on a loan you always intended to retire in two years is throwing money away.
It can also be the only debt available for a building that is not yet stabilized. Lenders who write fixed-rate loans generally want to see a full year of steady income first. A property with 30% vacancy and a construction budget is a bridge-loan candidate, and bridge loans float.
The exposure is time. Every month the renovation runs late is a month closer to the cap expiring and the loan maturing, with the rate still resetting. Floating debt rewards sponsors who finish on schedule and punishes the ones who do not, and the punishment arrives exactly when the building is least able to absorb it.
Many sponsors who used floating debt for a value-add plan in 2021 and 2022 learned this the hard way, when benchmark rates rose faster than their caps had been priced for. That is a lesson about matching the loan to the plan, not an argument that floating debt is wrong. It is wrong for a long hold and right for a short one.
Questions to Put to the Sponsor
Whichever structure is proposed, the offering memorandum should let you answer these. If it does not, ask.
- What is the all-in rate today, and for a floating loan, what is the spread over which benchmark?
- If floating, what is the cap strike, when does the cap expire, and what is budgeted to replace it?
- If fixed, what is the prepayment formula, and what would it cost to exit in year two and year four?
- What is the maturity date, what does each extension require, and what does it cost?
- Does the business plan finish before the loan does, with time to spare?
- Which line in the projection changes if the rate is 200 basis points higher at the first reset or the refinance?
The last question is the one that separates a sponsor who has stress-tested the debt from one who has copied a lender’s quote into a spreadsheet. A thoughtful answer names a number and explains what they would do about it. Debt structure and the risk many real estate investors miss goes further into why that answer matters more than the headline rate.
At VisionWise Capital we hold Southern California multifamily for the long term, so our bias is toward debt whose cost we know. The reasoning behind that bias, and the leverage discipline it sits on top of, is laid out in why we keep loan-to-value below 50%. Whatever a sponsor chooses, they should be able to explain it in the terms above without reaching for a rate forecast.
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This content is for informational purposes only and does not constitute investment, legal, or tax advice. Real estate transactions and private placements involve significant risk, including potential loss of principal. Always consult qualified legal, financial, and tax professionals before making investment decisions.
Related Reading
- How Interest Rates Affect Private Real Estate Debt
- Loan Maturity and Refinancing Risk in Private Real Estate
- Conservative Leverage Checklist for Accredited Investors
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