How to Choose a Rate Cap Broker [Updated May 2021]
As everyone knows, the economic environment is very different now from back in April 2017 when this post was first published. Here is an update pointing out what to think about as of May, 2021
As a commercial real estate broker, lender, attorney, or accountant, likely you are often asked by a borrower, “Who should I call to help me purchase the interest rate cap my lender is requiring for my floating rate loan?” You may have a “short list” of cap brokers, or no list at all because of your concern a recommendation for one rate cap broker over another might come back to haunt you. Regardless, while you may be comfortable with the cap broker you’re used to working with to “get it done”, are you truly aware of the differences between cap brokers? Should you care? Absolutely! If a Ferrari costs as much as a Ford, which car would you buy? The right decision is obvious.
As a borrower, it’s critical that the rate cap is purchased in a cost-effective, efficient and error-free manner. Cost-effective means that the rate cap broker’s fees are transparent throughout the process, and that the rate cap is optimally structured to both comply with the lender’s requirements, while incorporating important aspects that match your investment goals for the asset being financed.
Bottom line, here are two points that you must understand: 1) All reputable cap brokers receive the same pricing from the banks that sell rate caps. 2) The difference between cap brokers is the level of service they bring to the table, their experience, their ability to offer money saving ideas, the competitiveness of their fees, and the time they take to educate. Regardless of which cap broker is being referred, use the following list of best practices to ensure the best outcome for you and the borrower:
Rule Number 1: The indicative rate cap cost (aka “premium”) should never, ever be a factor in the decision on which rate cap broker to use. Why? There are simply too many variables and assumptions that go into calculating a rate cap’s cost, and the risk of these variables being inconsistent among cap brokers at any given moment in time is very high, resulting in distorted “quotes”. Hence, if you’re looking at two rate cap “quotes” obtained from two cap brokers and trying to decide which to go with based purely on price, you could be comparing apples to oranges, unfairly valuing one broker’s quote over another. All top-tier rate cap brokers receive the same level of competitive pricing from the rate cap banks.
When seeking “quotes” from multiple cap brokers, make sure you ask yourself:
- Do the trade assumptions and time of pricing (day and time of day) match? Term, notional, strike, index, start date, end date, day count and amortization, to name just a few, have a significant impact on the cap’s price.
- Make sure the cap broker is obtaining quotes directly from at least two banks and providing you and the borrower with a cost range on a regular basis up until closing. That way, you will have a sense of how variable the cost is between institutions and how prices are changing over time and why.
- Is the cap agent including its fee in the cap price? If yes, why? Wouldn’t the borrower be better served by knowing the cap’s cost separate from the cap broker’s fee? In this day and age, transparency in all things financial is key.
Who likes surprises? When it comes to money, no one – especially the borrower. A top-tier rate cap broker will provide routine and frequent updates on the anticipated cost the rate cap throughout the closing process, while providing market driven reasons for any price changes along the way.
Rule Number 2: The cap broker should be in charge of the entire process of acquiring the cap, from initial information gathering, onboarding, documentation distribution and completion, to trade execution and confirmation. If you are being asked to explain to your borrower a noteworthy change in the rate cap cost, cap related documents that you don’t fully understand, or shuffle documents between borrower and cap broker, ask yourself
- Who is doing all the work, me or the cap broker? Is the rate cap broker completing all the onerous Dodd-Frank documentation, explaining it to the borrower, obtaining the required LEI number, and gathering documentation to qualify the borrower to trade with the cap banks, not to mention intermediating with the cap banks to address any issues that may arise in the onboarding process?
- Do I understand the liability I’m creating for myself by being involved in the process of acquiring the cap? What if the cap process blows up at the last minute and delays the loan closing? Am I being compensated for the liability I’m creating for myself?
- How confident am I that the cap terms mirror those of the loan, as typically required by the lender?
Bottom line: Hire a professional, that transacts rate caps all day, every day and put your mind at ease.
Rule Number 3: A cap purchaser needs to know if they are getting their money’s worth from a cap broker. The loan takes priority, and the last thing a borrower or mortgage broker needs to worry about is buying the required cap. When contemplating the value received/fees paid ratio of your rate cap broker, consider the following:
- Rate cap brokers charge similar prices for their services. The difference is in what services are actually provided for the stated fee. Some charge extra for obtaining an LEI number or require the borrower mortgage broker to pitch-in on some of the work the cap broker should be doing, and there are a few rate cap brokers out there that pay fees to attorneys or mortgage brokers for referrals.
- If the cap isn’t properly documented at closing, then the lender, broker, and borrower have a serious problem. The loan may not fund, the buyer loses their deposit, additional legal expenses are incurred; the list goes on and on. Be careful; by accepting a referral fee from a cap broker you could be on the hook for some of the liability if things go sideways. Is it worth it? Probably not.
The broker and borrower should not have to endure the experience of going through the process without expert advice. And they certainly shouldn’t have to spend time filling out paperwork that the cap broker can and should do on behalf of the borrower more efficiently. Never accept a request to do some of the heavy lifting on the rate cap from your rate cap broker. Insist that they earn their money.
Rule Number 4: A cap broker that claims they receive preferential pricing form the rate cap banks – due to their size of the number of rate caps they claim to be involved in on a daily basis – isn’t necessarily the best choice. Choose your rate cap broker based on their ability to make the borrower’s interest their priority, their responsiveness, their experience in capital markets, legal knowledge, ability to manage complexity and meet critical deadlines, all with efficiency, and a smile. When confronted with a large, volume-heavy rate cap broker, consider:
- Large rate cap brokers who’s business model is based upon volume generally put their own process ahead of yours, the borrowers’ and the lenders’ interests. They favor conducting a rate cap purchase around their operational constraints rather than on negotiating the lowest cost rate cap at the best terms for the borrower.
- Think about it: A rate cap broker conducting a large volume of transactions simply can’t tolerate a great deal of customization in their factory-like process and still operate profitably. As a result, the cap buyer and real estate broker are burdened by doing some of the work the cap broker should be completing. Let’s not forget, the goal is closing the loan, not buying the rate cap.. Any time that a borrower or real estate broker spends on the rate cap is better spent focused on closing the loan. Want to do what you do best and leave the rest to a professional? Forget about the cap by hiring a firm with decades of experience.
- If another cap agent can obtain the rate cap at the same price, at the best available terms, do all the legwork, with seamless execution, all at a lower fee, why wouldn’t you recommend them to your borrower?
Is there a firm with deep capital markets experience, who takes a “white glove” approach, focuses on education first, offers money-saving ideas, and has a business model that isn’t volume based? Click here to find a cap broker which meets all those qualifications: Derivative Logic
Pro tip: Use Derivative Logic and experience the difference.
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Curious where rates are headed in 2024? Plan now to attend our Q1-2023 Interest Rate Outlook livestream, on Wednesday, December 13th.
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