We frequently receive inquiries from clients who wonder what their options are when they pay off their loan but still have a cap outstanding. Once the loan is paid off, you’re free to do what you want but it typically comes down to one of the following:
Do nothing
The bank that sold the cap doesn’t care if there’s an underlying loan in place. The hedge could continue to be held, and if LIBOR/SOFR exceeds the strike, the hedge provider will continue to make payments.
Some clients choose this option and recognize the hedge payments as additional cashflow or allocate them internally to another property.
Novate to another entity
In lieu of doing nothing, some clients will novate the cap from the previous borrower to a different property or even a parent level entity. In order to novate, the new entity will need to be onboarded and some banks may charge up to a few grand to cover documentation fees.
The existing cap could also be moved over to meet the hedge requirement on a different loan. If the terms don’t exactly align, changes such as upsizing the notional, lowering the strike, extending the term, etc. can be made and the borrower would just owe the net difference in economic value.
Terminate
The cap can be unwound, and any remaining residual value recouped. The remaining value is largely a factor of the amount of time remaining and where the strike is set.
If just a couple months remain and the strike is set at 6.00%, there’s likely not much residual to be recouped. If a year remains and the strike is set at 3.00%, the residual value could be several times what was initially paid for the cap.
If you recently paid off a loan or have one coming up soon and would like to discuss options, please don’t hesitate to reach out.
