LIBOR - the London Interbank Rate is nearing the end of its lifespan
In my lifetime, the LIBOR rate adjustments were an accepted rate in many commercial lending documents. This is now coming to an end and banks are scuttling about adapting other indexes.
History
The London Interbank Offered Rate (LIBOR) was born out of a need for an interest rate to charge Iran for an 80 million-dollar loan in 1969. Minos Zombanakis, Iran’s Banker at the time, helped form a syndicate of banks to fund this need with a loan rate that could be pegged to the then-current and rising market interest rates, plus a profit. (1) It was set each day by collecting estimates from up to 18 global banks on the interest rates they would charge for different loan maturities, given their outlook on local economic conditions. This rate was included in loan documents for loans that were being originated.
At that time LIBOR was calculated in five currencies, UK Pound Sterling, the Swiss Franc, the Euro, the Japanese Yen, and the U.S. Dollar, and was calculated, daily, weekly, monthly, bimonthly, trimonthly, every six months, and every twelve months. “The London Interbank Offered Rate was used to price adjustable-rate mortgages, asset-backed securities, municipal bonds, credit default swaps, private student loans, and other types of debt. As of 2019, $1.2 trillion worth of residential mortgage loans and $1.3 trillion of consumer loans had been priced using LIBOR.” (2)
Its fall from grace was triggered by a series of scandals. It was discovered that some bankers, brokers and traders were rigging the LIBOR rate to increase their profits. After many extensions, the LIBOR will be replaced in the United States, by the Secured Overnight Finance Rate (SOFR) index at the final deadline of June 30, 2023.
In addition to the SOFR, four other rates were devised to meet the banking needs of the future:
SONIA - aligns with Pound sterling-based loans.
TONAR - meets the needs of Tokyo (Yen) based lending.
SARON - the Swiss franc overnight loan rate.
ESTR - the Euro short term rate average.
Let’s focus on the Secured Overnight Finance Rate (SOFR). In 2014, the Federal Reserve convened a committee to develop an alternative interest rate indicator (Alternative Reference Rate Committee, ARRC). They developed the SOFR Rate. This rate is the main replacement for LIBOR in the United States. This benchmark is based on the rates U.S. financial institutions pay each other for overnight loans. “These transactions take the form of treasury bond repurchase agreements, otherwise known as repos agreements. They allow banks to meet liquidity and reserve requirements, using treasuries as collateral. SOFR comprises the weighted averages of the rates charged in these repo transactions.” (3)
How does this affect real estate investors?
As the transition from LIBOR to SOFR evolves, borrowers may find that their loans may be more stable and not as liable to manipulation. The foundation of the SOFR is based upon trillion dollars of daily transactions a day and supported by US Treasuries. This should de-risk existing loans based on LIBOR. (4) New loans based on SOFR will be adjusting upwards/downwards as the Federal Reserve keeps making interest rate decisions in its battle to tame inflation. Investors will find that SOFR-based loans will be of a shorter-term nature (three to five years) as Lenders hedge their bets against the economy.
SOFR is the de facto lending index to match to for US lenders — just ask the federal government. “HUD is removing the London Interbank Offered Rate (LIBOR) as an approved index for adjustable interest rate mortgages (ARMs) and replacing LIBOR with the Secured Overnight Financing Rate (SOFR) as a secretary-approved index for newly originated forward ARMs.” (5)
The bottom line is that investors will be finding all of their LIBOR-based loans being modified to use the SOFR index, and all new loans will also be adjusted by the SOFR index. The benefit to the investor is clarity, but don’t expect to save any money with the new index.
Sources
(1) The Economist, May 20th, 2023, The End of LIBOR
(2) https://www.forbes.com/advisor/investing/what-is-libor
(3) https://www.cmegroup.com/education/courses/introduction-to-
sofr/what-is-sofr.html
(4) https://terrydalecapital.com/learn/sofr-financing-blog/
(5) https://www.federalregister.gov/
documents/2023/03/01/2023-03952/adjustable-rate-mortgages-
transitioning-from-libor-to-alternate-indices
Clifford A. Hockley, CPM, CCIM, MBA
Cliff is a Certified Property Manager® (CPM) and a Certified Commercial Investment Member (CCIM). Cliff joined Bluestone and Hockley Real Estate Services 1986 and successfully merged that company with Criteria Properties in 2021.
He has extensive experience representing property owners in the sale and purchase of warehouse, office, and retail properties, as well as mobile home parks and residential properties. Cliff’s clients include financial institutions, government agencies, private investors and nonprofit organizations. He is a Senior Advisor for SVN | Bluestone.
Cliff holds an MBA from Willamette University and a BS in Political Science from Claremont McKenna College. He is a frequent contributor to industry newsletters and served as adjunct professor at Portland State University, where he taught real estate-related topics. Cliff is the author of two books, 21 Fables and Successful Real Estate Investing; Invest Wisely Avoid Costly Mistakes and Make Money, books that helps investors navigate the rough shoals of real estate ownership. He is the managing member of a real estate consulting practice, Cliff Hockley Consulting, LLC., designed to help investors and commercial brokerage owners successfully navigate their businesses. He can be reached at 503-267-1909 , Cliffhockley@gmail.com or Cliff.Hockley@SVN.com.
