If you have taken out a commercial real estate loan, a business line of credit, or any floating-rate financing in the past few years, you have likely encountered a term that was once unfamiliar to most borrowers: SOFR. The Secured Overnight Financing Rate has officially replaced the London Interbank Offered Rate, better known as LIBOR, as the dominant benchmark interest rate in U.S. commercial lending. Understanding what SOFR is, why the transition happened, and how it affects your borrowing costs is no longer optional knowledge for serious commercial real estate investors and business owners. It is essential.
What Is SOFR and Where Does It Come From?
SOFR stands for the Secured Overnight Financing Rate. It is a broad measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities. Published daily by the Federal Reserve Bank of New York, SOFR reflects actual transaction data from the Treasury repurchase agreement, or repo, market. This is a critical distinction from LIBOR, which was based on estimates submitted by a panel of banks rather than real, observable market transactions.
The repo market that underlies SOFR is one of the most liquid short-term funding markets in the world, with daily transaction volumes regularly exceeding one trillion dollars. Because SOFR is grounded in real trades rather than bank estimates, it is considered a far more transparent and manipulation-resistant benchmark than its predecessor.
SOFR was first published in April 2018 after the Alternative Reference Rates Committee (ARRC), a group convened by the Federal Reserve and the New York Fed, selected it as the preferred replacement for U.S. dollar LIBOR. The transition timeline was gradually enforced, and by June 30, 2023, the publication of all U.S. dollar LIBOR settings officially ceased, completing one of the most significant transformations in global financial market infrastructure in decades.
Why LIBOR Had to Go: The Scandal and the Structural Problem
To appreciate why SOFR matters, it helps to understand why LIBOR became untenable. LIBOR was used for decades as a reference rate for hundreds of trillions of dollars in financial contracts worldwide, from mortgages and student loans to corporate bonds and interest rate derivatives. Its calculation, however, depended on daily submissions from a small panel of major banks, each reporting the rate at which they believed they could borrow funds in the interbank market.
"At its peak, LIBOR was embedded in an estimated $300 trillion worth of financial contracts globally, making its manipulation one of the most consequential financial scandals of the 21st century."
Beginning around 2012, it emerged that multiple major financial institutions had been manipulating their LIBOR submissions, either to profit on derivative positions or to project an artificially healthy financial image during the 2008 financial crisis. Regulatory investigations led to billions of dollars in fines and criminal prosecutions across multiple countries. Even after reforms were introduced, a deeper structural problem remained: the interbank lending market that LIBOR was supposed to measure had become too thin to support reliable rate-setting. There simply were not enough real transactions to back the benchmark. The financial industry needed a replacement built on solid, verifiable ground.
How SOFR Works in Commercial Loan Structures
In commercial real estate and business lending, SOFR typically appears in one of three compounded or averaged forms, each with slightly different calculation methodologies. The most common structures lenders use include:
- Term SOFR: A forward-looking rate published for one, three, six, or twelve-month tenors by the CME Group. This is the most widely adopted version in commercial real estate loans because it allows borrowers and lenders to know the rate at the beginning of an interest period, much like LIBOR once functioned.
- Daily Simple SOFR: Calculated using the overnight rate without compounding, applied to the loan balance each day over a period. This is simpler to calculate but less common in CRE loan documents.
- SOFR Compounded in Arrears: Calculated by compounding daily SOFR rates over a period and applied at the end. This version is more common in capital markets and syndicated lending.
- 30-Day Average SOFR: A smoothed average of daily SOFR readings over a rolling 30-day window, often used in adjustable-rate structures for its stability relative to single-day spikes.
For most commercial borrowers dealing with banks, credit unions, debt funds, or CMBS lenders, Term SOFR is the version most likely to appear in their loan agreements. As of early 2025, one-month Term SOFR was hovering in the range of 4.30 to 4.60 percent, reflecting the Federal Reserve's elevated benchmark rate environment following its aggressive tightening cycle. Lenders typically add a credit spread on top of Term SOFR to arrive at the final loan rate, just as they added a spread over LIBOR in prior years.
What the SOFR Transition Means for Commercial Borrowers in 2025
For most commercial real estate borrowers, the day-to-day experience of dealing with a SOFR-based loan is not dramatically different from the LIBOR era. You still receive a periodic rate notice, your rate still adjusts at defined intervals, and your lender still calculates interest based on that benchmark plus a negotiated spread. However, there are meaningful nuances that informed borrowers should understand before executing loan documents.
One important consideration is the credit spread adjustment. When existing LIBOR loans were converted to SOFR, lenders and regulators applied a spread adjustment, typically around 11.4 basis points for one-month instruments and 26.2 basis points for three-month instruments, to account for the historical difference between LIBOR and SOFR. For new loans originated directly in SOFR, this adjustment is not automatically applied, meaning borrowers should scrutinize spread language carefully when comparing competing loan proposals.
Another practical implication involves interest rate caps and hedging. Borrowers with floating-rate bridge loans or construction loans who purchased LIBOR-based interest rate caps have already transitioned those instruments to SOFR equivalents. For borrowers entering new floating-rate deals in 2025, purchasing a SOFR-based interest rate cap remains a widely recommended risk management strategy, particularly given ongoing uncertainty about the Federal Reserve's rate trajectory in the second half of the year.
Additionally, borrowers should be aware that SOFR, as an overnight rate, tends to be slightly lower than LIBOR was in comparable environments due to its secured, collateralized nature. Over time, this may translate into marginally lower baseline rates for borrowers, though the spread charged by individual lenders ultimately determines the all-in cost of financing.
Looking ahead, the commercial lending industry has largely completed the infrastructure work required to operate in a SOFR world. Loan origination platforms, servicing systems, and legal documentation frameworks have been updated across the industry. The focus in 2025 and beyond will shift toward how SOFR behaves through a full economic cycle, how it responds during periods of market stress, and whether any refinements to Term SOFR conventions will be adopted by regulators or market participants. For investors, staying informed about benchmark rate developments remains as important as ever, particularly when navigating refinancing decisions, floating-to-fixed conversions, or new acquisitions in a still-elevated rate environment.
