Research Brief: Capital Markets – June 2022

Tightening monetary policy highlights utility of rate swaps and caps. Commercial real estate investors have long had multiple avenues for hedging against rising interest rates. The Federal Reserve’s commitment to raising interest rates, renewed by higher-than-anticipated CPI inflation in May, has brought these options back to the forefront of many borrowers’ minds. For investors with floating rate debt, there are two prominent options to hedge against rate climbs: an interest rate swap and cap. A swap offers an investor an opportunity to exchange a floating interest payment for a fixed-rate payment for a certain period of time. A cap, on the other hand, fixes an upper limit on the rate a borrower will pay at the cost of an upfront payment. In the event that interest rates advance higher than the market anticipated, these types of positions can help investors avoid additional capital costs. However, if rates do not rise as much as expected, the borrower may have spent capital unnecessarily or incurred additional cost.

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