Why is SOFR more Volatile than LIBOR?

Part of Are Fannie Mae Loans Non-Recourse for Multifamily?

Table of Contents

1. What is SOFR Interest Rate?
2. Why is SOFR more Volatile than LIBOR?
3. What are the Limitations of SOFR?
4. How is SOFR Different from LIBOR?
5. Other reasons why the SOFR is more Volatile than the LIBOR
6. Frequently Asked Questions About The Limitations of the SOFR
7. Why SOFR is More Volatile Than LIBOR - Conclusion
8. Sources

SOFR is more volatile than LIBOR was because of a fundamental structural difference in how the two rates are constructed. SOFR is an observed overnight rate based on real Treasury repo transactions, published every business day by the Federal Reserve Bank of New York. LIBOR was a forward-looking term rate built from a daily survey of a small panel of banks estimating where they could borrow unsecured. Observed rates show the underlying market's day-to-day volatility; survey rates smoothed it. The transition from LIBOR to SOFR replaced a smoothed survey-based estimate with a hard-data observed price, and the volatility that LIBOR's construction was concealing simply became visible.

USD LIBOR ceased publication on June 30, 2023, completing the ARRC-led transition that began in 2017 after the LIBOR-manipulation scandals exposed how vulnerable a survey-based rate could be to coordinated misreporting by submitting banks. SOFR (Secured Overnight Financing Rate) is now the reference rate for the vast majority of floating-rate commercial real estate debt, including most bridge loans, construction loans, and any non-agency floating-rate structure that previously referenced 1-month or 3-month LIBOR. The transition is complete and not ongoing; the practical question for any LP looking at floating-rate exposure today is what SOFR's volatility means for debt service on the underlying property, not whether the rate is going to change again.

This guide explains how SOFR is constructed and why that construction produces more day-to-day volatility than LIBOR did, the practical limitations of an overnight rate referenced into longer-duration loans, the specific structural differences between the two rates, the market-mechanical drivers of SOFR spikes, and what the volatility actually means for an LP evaluating a deal with any floating-rate component in the capital stack.

What is SOFR Interest Rate?

SOFR (the Secured Overnight Financing Rate) is the Federal Reserve Bank of New York's daily measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. It is calculated from actual transactions in the Treasury repurchase market, where dealers and counterparties exchange Treasury collateral for overnight cash, and it is published every business day at approximately 8:00 a.m. Eastern time based on the prior business day's trading. The underlying transaction volume that feeds SOFR is roughly $1 trillion per day, which is several orders of magnitude larger than the transaction volume that ever supported LIBOR.

As a rate, SOFR is structurally specific in three ways that matter for how it behaves. It is secured: the lender holds Treasury collateral against the cash advanced, so SOFR has almost no credit-risk component. It is overnight: each day's published SOFR is for cash deployed for one business day only, with no term-structure information embedded. And it is observed: SOFR is calculated from completed trades at known prices and volumes, not from estimates or projections. The CME-published Term SOFR provides 1-month, 3-month, 6-month, and 12-month forward-looking analogs to spot SOFR by reading rates implied from SOFR futures contracts, and it is the rate most floating-rate commercial real estate debt actually references.

Why is SOFR more Volatile than LIBOR?

SOFR is more volatile than LIBOR because its construction reveals the underlying market's true day-to-day cost of secured overnight funding rather than smoothing it through a survey methodology. LIBOR was published as a single forward-looking term rate at each tenor (1-month, 3-month, 6-month, 12-month) derived from a daily survey of a panel of banks estimating where they could borrow unsecured for that tenor. Survey-based construction necessarily smooths volatility because submitting banks tend to avoid extreme estimates that would draw attention to their own funding stress, and because the survey methodology averages across the panel. The result was a rate that drifted gradually most days, with sharp moves limited largely to scheduled monetary policy events.

SOFR, by contrast, captures the actual price of overnight secured funding in a market where transactions clear at observable rates. When demand for cash spikes in the Treasury repo market (which happens for predictable structural reasons at quarter-end, year-end, and around large Treasury settlement dates), SOFR spikes with it. When supply spikes, SOFR drops. The volatility is not a flaw in the rate; it is the rate doing exactly what it is designed to do, which is report the market's actual cost of overnight funding without smoothing. Term SOFR damps much of this daily volatility for loan-pricing purposes by reading rates implied from longer-dated SOFR futures, but the spot rate itself remains observably more variable than LIBOR ever was.

What are the Limitations of SOFR?

The single largest structural limitation of SOFR is that it is an overnight rate being asked to do the work of a term rate. A multifamily bridge loan with a three-year term needs forward-looking rate pricing across that horizon, but SOFR itself only reports yesterday's overnight cost. The market has solved this in two ways. The first is Term SOFR, which uses SOFR futures to construct forward-looking 1-month, 3-month, 6-month, and 12-month rates; this is the rate most floating-rate CRE debt today actually references. The second is SOFR-in-arrears compounding, where the floating-rate period is priced after the fact by compounding daily SOFR observations over the period; this is the convention preferred for derivatives and some institutional debt but is operationally more complex for commercial real estate borrowers.

The second meaningful limitation is that SOFR is a secured rate and therefore carries almost no bank credit-risk premium, while bank lending costs do carry such a premium. When banks borrow unsecured (as the LIBOR panel did), the rate they pay includes both the risk-free rate and a credit spread. When SOFR is used as the reference rate for a bank loan, the credit-risk component has to be added separately as part of the loan spread, which is one reason SOFR-referenced bridge debt typically prices at SOFR plus 250 to 450 basis points rather than at much tighter spreads. The structural divergence between secured-rate movements (SOFR) and unsecured bank funding costs occasionally widens during stress periods, which can compress lender margins on SOFR-referenced loans in ways the original LIBOR-referenced framework did not.

How is SOFR Different from LIBOR?

The two rates differ on essentially every structural dimension. Source: SOFR is calculated from observed transactions in the U.S. Treasury repo market; LIBOR was built from daily survey responses from a panel of large international banks. Collateralization: SOFR is secured by Treasury collateral; LIBOR was unsecured interbank lending. Tenor: SOFR is overnight in its native form; LIBOR was published at multiple tenors (overnight, 1-week, 1-month, 2-month, 3-month, 6-month, 12-month) directly. Volume basis: SOFR sits on roughly $1 trillion in daily Treasury repo transaction volume; LIBOR in its later years was supported by a transaction base that had shrunk to a tiny fraction of the rate's broader market relevance, which was part of the regulatory case for its replacement.

The construction difference matters because it changes who can influence the rate. The LIBOR survey methodology was vulnerable to coordinated misreporting by submitting banks, which was demonstrated in the LIBOR-manipulation scandals that drove the regulatory push to replace the rate. SOFR's observed-transaction construction is much harder to manipulate because changing the rate would require executing manipulative trades in a market where roughly $1 trillion clears daily, an undertaking with significant cost and regulatory exposure. The replacement of LIBOR with SOFR therefore traded one set of trade-offs (a smoothed but manipulable survey rate) for another (a less smooth but transaction-grounded observed rate), and the volatility difference is the visible artifact of that trade-off.

Other reasons why the SOFR is more Volatile than the LIBOR

Beyond the structural construction difference, several recurring market-mechanical drivers produce specific SOFR volatility patterns that LIBOR did not exhibit. Quarter-end and year-end balance sheet management at major banks reduces the supply of repo financing as banks tidy their balance sheets for regulatory reporting purposes, which can drive SOFR sharply higher in the days approaching those reporting dates. Treasury settlement timing creates predictable demand spikes when large Treasury auctions settle and dealers need cash to fund their newly-acquired positions. Corporate tax payment dates pull cash out of money market funds and money-center banks at known calendar points, reducing the supply of overnight cash available in repo.

The most extreme historical example of SOFR volatility is the September 2019 repo market stress, when overnight SOFR spiked from around 2 percent to over 5 percent intraday for several days before the Federal Reserve intervened with standing repo operations. The proximate causes were a confluence of corporate tax payments and Treasury settlements drawing reserves out of the system simultaneously, and the broader cause was the post-crisis bank balance sheet structure that constrained dealers' ability to arbitrage the spike. None of these dynamics would have moved LIBOR meaningfully in its survey-construction days, but all of them move SOFR because SOFR reports what is actually happening in the repo market rather than what banks estimate they could borrow at.

Frequently Asked Questions About The Limitations of the SOFR

Why SOFR is More Volatile Than LIBOR - Conclusion

The volatility difference between SOFR and LIBOR is a structural artifact of how the two rates were constructed, not a defect in SOFR or a virtue of LIBOR. SOFR reports the U.S. Treasury repo market's actual cost of overnight secured funding using a daily transaction volume of roughly $1 trillion, while LIBOR reported a panel of banks' daily estimates of their unsecured term borrowing costs. The observed rate is necessarily more variable than the smoothed survey rate because the underlying market it reports is variable, and the LIBOR survey methodology was structurally smoothing that variability away (along with concealing the manipulation that ultimately drove the rate's replacement).

For passive multifamily LPs, the practical takeaway is that SOFR exposure is bridge-debt-specific. Fixed-rate agency debt (Fannie Mae DUS, Freddie Mac Optigo, HUD-insured loans securitized by Ginnie Mae) is priced over the on-the-run Treasury benchmark for the matching tenor, not over SOFR. Willowdale's current Texas portfolio runs on fixed-rate agency debt and is therefore not directly exposed to day-to-day SOFR movements. When a deal includes a floating-rate bridge loan referenced to Term SOFR (which is common during heavy-reposition acquisitions where agency won't size to in-place income), the operator's job is to manage the volatility through caps, swaps, or fixed-payment structures, and the LP-side question is whether the underwriting prices that exposure conservatively enough to survive the kinds of repo-market stress events that have become predictable features of the post-LIBOR rate environment.

Sources

1. Federal Reserve Bank of New York — Secured Overnight Financing Rate (SOFR) Data
2. Federal Reserve Bank of New York — Alternative Reference Rates Committee (ARRC)
3. Federal Reserve — Joint Statement on Managing the LIBOR Transition (Nov 30, 2021)