Floating Rate Modeling

I was wondering how detailed is everyone's modeling of a proforma with a floating interest rate. Is it estimation, interpolation, or do you just use the base rate throughout the proforma?

I figured that one would have to look at the yield curve and model that plus the base rate to get the all in rate for 3-year floating rate construction. Is there anyone that underwrites it to more than 1st year DSCR and 1st year all in rate, I mean we have to assume at the end of year 3 that you are paying more in interest since rates will be higher?

 

A lot of floating rate lenders require the borrower to purchase an interest rate cap. So you model year 1 and then max interest.

If you aren't required to purchase the interest rate cap, then most likely there is some sort of yearly DY test or DSCR test (trailing 12) and if you trip the trigger, something happens (cash flow sweeps, LOC requirements, or pay downs).

 

REAcquisitionsNYC method is probably more accurate. Both my current and the previous shop I worked at started with the base rate then included an annual escalation amount usually 50 bps although sometimes we'd use 25 bps. If we had a cap/floor this would obviously be account for. We will typically compare this to a fixed rate loan although I think this method is flawed since at 50 bps a year you've probably escalated well more than reality.

 

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