When it comes to managing floating-rate debt in commercial real estate (CRE), most sponsors are familiar with interest rate caps and swaps. After all, they’re the standard go-to tools — and for good reason. But for certain business plans, market conditions, or portfolio strategies, they may not offer the optimal balance of flexibility, cost, and protection. That’s where alternative hedging strategies come in. Tools like interest rate collars, floors, and swaptions can offer more customized solutions, giving sponsors a way to manage exposure with precision. Yet these instruments are often underutilized in the mid-market CRE space, either due to lack of awareness or limited advisory support. In this article, we’ll break down how each tool works, when they’re useful, and how to think about hedging as part of your broader capital strategy.
Why Look Beyond Caps and Swaps?
- Rate caps are great for flexibility but come with upfront costs that can spike in volatile markets.
- Swaps lock in certainty, but if interest rates decline and the Borrower is forced to terminate the swap, the swap provider may require a swap termination fee.
Depending on your risk profile, deal timeline, and view on forward rates, you may want a hedge that sits somewhere in between.
Strategy 1: Interest Rate Collars
What It Is:
An interest rate collar is a strategy that combines a rate cap and a rate floor. You purchase a cap (to protect against rising rates) and simultaneously sell a floor (agreeing to a minimum rate if interest rates drop too far). The premium you earn from the floor helps offset the cost of the cap.
How It Works:
- Cap strike: You pay nothing above this rate.
- Floor strike: You receive less benefit if rates fall below this level.
Why Use It:
- You can reduce the cost of a cap without sacrificing all upside.
- This option is ideal for borrowers who believe rates could rise but are willing to limit benefit if rates fall sharply.
Example:
A borrower with a $40M floating rate loan purchases a 3.50% cap and sells a 1.00% floor. The floor premium offsets 50–60% of the cap cost. If SOFR stays between 1.00% and 3.50%, they pay market rates. If SOFR rises above 3.50%, they’re protected. And if it drops below 1.00%, they don’t benefit beyond that.
Advisory Insight:
Collars are useful when you’re operating in a narrow budget range and want protection + cost efficiency. They require strong modeling to assess the impact of lost downside benefit.
Strategy 2: Interest Rate Floors (Standalone)
What It Is:
A rate floor is a contract that sets a minimum interest rate — often used by lenders to ensure they earn a base return. But borrowers can sell a floor independently as a way to generate premium income — or as part of a collar, as discussed above.
How It Works:
- If you sell a floor, you agree to pay a minimum rate even if SOFR drops below the floor strike.
- In return, you earn an upfront premium from the counterparty.
Why Use It:
- This option can offset the cost of other hedges (e.g., a rate cap).
- You can monetize the expectation that rates won’t drop significantly below the floor level.
Example:
A borrower sells a 1.00% floor on a $30M loan and uses the $75K premium to reduce the cost of a 2-year, 3.50% cap. Rates stay above 1.50% for the duration of the loan, so the floor is never triggered, and the borrower keeps the premium.
Advisory Insight:
Selling a floor adds downside risk, so it’s best used by professionals who are confident that rates won’t drop below a certain threshold, or who want to blend risk and cost efficiency.
Strategy 3: Swaptions (Options on Interest Rate Swaps)
What It Is:
A swaption is an option to enter into an interest rate swap at a future date. It gives the borrower the right, but not the obligation, to lock in a fixed rate starting at a specified time.
How It Works:
- Pay a premium today to secure the right to enter a swap in the future.
- If rates rise, you exercise the option; if rates fall, you let it expire.
Why Use It:
- You can delay commitment to a fixed rate until closer to loan maturity or refi window.
- This is useful for borrowers who are unsure about their refinance timing or long-term rate direction.
Example:
A borrower with a $25M loan maturing in 18 months buys a swaption to lock in a 4.00% fixed rate starting in 12 months. If rates rise to 5.00%, they exercise and lock in the 4.00% swap. If rates fall, they let it expire and refinance at lower prevailing rates.
Advisory Insight:
Swaptions are less common in mid-market CRE, but they offer extreme flexibility when used correctly. They’re most valuable in volatile rate environments where timing your hedge is essential.
Strategy 4: Forward Starting Swaps
What It Is:
A forward starting swap locks in a fixed interest rate today, but the payments don’t start until a future date, which is useful for refinancing visibility and budget forecasting.
How It Works:
- Agree today to swap into a fixed rate in the future.
- This option is useful if you have a floating rate loan that you plan to refinance or pay off but want to manage risk in the interim.
Why Use It:
- Secure a favorable fixed rate now based on lower FWD rates.
- Mitigate refinancing risk without breaking current loan structure.
Example:
A CRE owner has a floating rate loan maturing in 12 months. They enter a forward starting swap to lock in 5.25% starting at maturity, giving them budget certainty in case rates spike over the next year.
Advisory Insight:
This strategy is best suited for sponsors with high conviction on rate direction or who need budget stability to support investor communications and capital planning.
Choosing the Right Hedging Strategies: It’s All About Alignment
Each of these lesser-used hedging strategies provides a customizable risk-return profile. But they’re only effective if they’re aligned with your:
- Business plan
- Exit timeline
- Cash flow sensitivity
- View of the rate environment
- Lender requirements and constraints
This is where advisory support becomes critical — the tools are only as good as the strategic thinking behind them.
Final Takeaways
- Traditional tools like caps and swaps are effective, but not always optimal.
- Alternative hedging strategies like collars, swaptions, and forward swaps offer greater flexibility and can reduce total hedging costs.
- Hedging should be treated as a strategic part of debt planning — not just a lender checkbox.
Need a personalized hedge analysis?
Whether you’re weighing interest rate caps and swaps or exploring alternative hedging strategies like collars, floors, or swaptions, Defease With Ease | Thirty Capital’s advisory team can help you evaluate the full range of tools available. We’ll work with you to align your hedge with your cashflow, business plan, and rate outlook, so you get the protection and flexibility that best fit your portfolio.
Schedule a complimentary call with a debt advisor today.
