How to Hedge Interest Rate Risk in CRE: A 2025 Guide

Commercial real estate (CRE) has always been shaped by the cost of capital. In today’s environment, where short-term volatility and long-term uncertainty converge, effective interest rate hedging is both a defensive tool and a proactive strategy for portfolio optimization. For mid-market CRE owners and operators, the stakes are higher than ever: a poorly structured hedge can eat into cashflow, undermine refinancing options, or trigger loan covenant stress. 

This article offers a comprehensive framework for hedging interest rate risk, with examples, scenarios, and best practices tailored to CRE borrowers. 

Why Interest Rate Hedging Matters in 2025 

The last few years have shown how quickly rate environments can shift, from historically low levels in 2020–2021 to the sharp tightening that followed. These events serve as a reminder to borrowers that assumptions about ‘stable’ financing are fragile. 

In 2025, several dynamics are shaping the landscape: 

• Fed policy divergence: With inflation still moderating unevenly across sectors, the Federal Reserve is signaling cautious cuts, but the pace is uncertain. 
• SOFR forward curve volatility: Market expectations are shifting quarter by quarter, creating opportunities (but also risk) in hedge pricing. 
• Lender requirements: Many lenders now require borrowers to purchase caps, collars, or swaps as a condition for floating-rate debt. 

Without a hedge, rate volatility can quickly erode cashflow and push an otherwise profitable asset into breakeven or loss. 

Hedge Instruments: The Core Tools 

CRE borrowers typically rely on three main hedge instruments. Each has trade-offs in cost, flexibility, and alignment with financing objectives.

1. Interest Rate Caps

• What it is: An upfront premium limits floating-rate exposure above a set strike rate. 
• Use case: Short-term or bridge financing where flexibility is critical. 
• 2025 Insight: Cap pricing has softened compared to 2022–2023 highs, though forward curve expectations still drive premiums. Forward-starting rate caps remain an attractive way to lock in lower costs today for future protection. 

2. Swaps

• What it is: Borrower exchanges floating-rate payments for fixed payments over a set term. 
• Use case: Stabilized properties with predictable, steady cashflow. 
• 2025 Insight: Swaps provide certainty but limit flexibility; breakage costs can be significant if refinancing or an early sale occurs, making them best suited for assets with long hold periods. 

3. Collars

• What it is: A combination of a cap and a floor, limiting both upside and downside. Borrowers often lower upfront costs by agreeing to a minimum rate. 
• Use case: Borrowers seeking cost efficiency while accepting some limits on flexibility. 
• 2025 Insight: With forward curves suggesting gradual easing, collars may appeal to those who want inexpensive protection without the high upfront premiums of standalone caps. 

Additional Article: Lesser-Known Hedging Strategies: Understanding Your Options 

Key Scenarios: Applying Hedge Strategy 

Understanding hedge instruments in theory is useful, but the real value lies in seeing how they perform in practice. Every CRE borrower faces unique circumstances; loan maturities, property types, cashflow profiles, and exit timelines all shape the optimal hedge approach. These scenarios show how caps, swaps, and collars perform under different conditions and how advisory-driven structuring helps protect cashflow, preserve flexibility, and strengthen overall strategy. 

Scenario 1: Refinancing a Multifamily Loan in Q3 2025 

A borrower holds a $30M floating-rate loan expiring in September. The lender requires a hedge, and forward curves suggest SOFR may drop by 75 bps by year-end. 

• Option A: Buy a 12-month cap at 4.50% (premium $250,000). 
• Option B: Enter a swap at 5.25% fixed. 
• Decision: If the borrower expects to refinance into a fixed-rate loan within 12 months, the cap offers flexibility without swap breakage risk. 

Scenario 2: Industrial Portfolio with 5-Year Horizon 

A fund finances $100M across four assets on floating-rate bridge loans. Expected exit in 2029. 

• Option A: Swaps across each loan to fix long-term exposure. 
• Option B: Staggered caps with forward-starting features. 
• Decision: Staggered caps provide cost efficiency and preserve flexibility, especially if exit timing varies by asset. 

Scenario 3: Hedging Delay Risk 

A borrower anticipates refinancing in 2026 but wants to lock in hedge pricing today. 

• Forward-starting cap: Effective 12 months from now, protection begins at refinancing date. 
• Benefit: Borrower secures pricing now, avoiding potential volatility. 

Best Practices 

Effective hedging strategies start with alignment to the business plan: short-term bridge loans typically call for caps that preserve flexibility, while long-term stabilized holds are better suited for swaps. Borrowers should test cashflow, debt service coverage ratios (DSCR), internal rate of return (IRR), and equity multiple upon exit under multiple rate scenarios to understand how hedges perform. At the same time, they should stay vigilant about loan covenants, since DSCR or cash sweep triggers can be more damaging than rate levels themselves. Liquidity and timing are equally important, as hedges often require upfront premiums or collateral and pricing can move daily. 

Common Pitfalls 

Many CRE borrowers make avoidable mistakes when structuring hedge strategies. One of the most common missteps is over-hedging, locking in not only the loan balance but also excess exposure, which creates mismatches between debt obligations and hedge coverage. Another is ignoring the exit strategy; swaps in particular can carry substantial breakage costs if an asset is sold earlier than expected, erasing gains that the hedge was meant to protect. Timing is critical: borrowers who delay often face inflated premiums, as seen in late 2022 when two-year cap pricing nearly tripled within months. These pitfalls show that hedging is as much about timing and execution as the product itself. 

Additional Article: Debt Optimization 101: Avoiding Common Pitfalls

Conclusion 

In 2025, interest rate hedging is not a one-size-fits-all solution. Caps, swaps, and collars each have roles, but the key is aligning them with asset strategy, exit timing, and market dynamics. For borrowers navigating today’s uncertainty, hedging is less about “if” and more about “how.” 

If you’re evaluating hedging strategies, our team at Defease With Ease | Thirty Capital can provide a second opinion, real-time market insights, and scenario testing tailored to your portfolio. Send us a note and let’s explore your options together.