The short answer
A floating-rate DST loan charges a fixed spread over an index such as SOFR, so debt service rises when short-term rates rise, and the trust's rent does not rise with it. Lenders usually require a rate cap, a contract that pays the borrower when the index exceeds a strike rate, but only for the cap's term, and Freddie Mac requires monthly deposits building to 125 percent of the cost of a replacement cap when the first one expires before the loan. Because Rev. Rul. 2004-86 bars the trustee from renegotiating the loan or taking new financing, the trust cannot refinance into a fixed rate if rates climb. A filed DST loan shows the alternative: a swap fixing the rate for the full five-year term, bought for a premium of about 5.4 percent of the loan.
At a glance
| Index | SOFR; agency floating-rate loans price over 30-day Average SOFR |
|---|---|
| What a cap does | Pays the borrower the excess of the index over the strike rate, for the cap's term only |
| Initial cap cost | A permitted closing cost in the total acquisition cost on agency loans |
| Replacement cap reserve | Monthly deposits building to 125% of the estimated cost of a new cap |
| Cap must last | Until the loan is paid in full under the agency guide |
| If a cap lapses | The lender may charge the default rate or buy a cap with your payments |
| Filed DST example | One-month SOFR plus 2.5%, interest-only, five years, swapped to 5% for a $417,136 premium |
| Trust's constraint | No renegotiation or new financing except on tenant bankruptcy or insolvency |
Floating-rate debt moves the trust's largest expense while its rent stays fixed
Freddie Mac's floating-rate term sheet prices loans over 30-day Average SOFR for 5-, 7- and 10-year terms and offers interest rate cap options; its minimum debt coverage is 1.25 times, calculated on an amortizing payment even during interest-only periods. The OCC's Commercial Real Estate Lending handbook states the risk directly: when a project has floating-rate debt and fixed rents, increasing interest rates can hurt the borrower's repayment capacity.
A DST's rent is fixed by its lease or master lease, so a rate increase passes almost entirely to the distribution. How the debt payment sits ahead of your check is at how DST distributions are calculated; fixed-rate leverage and maturity risk are at DST leverage and interest-rate risk.
A rate cap limits the index for a set term, and the contract has its own costs and counterparty
A cap pays the borrower when the index rises above an agreed strike, so the effective rate cannot exceed strike plus spread while the cap is in force. An industrial REIT's 2025 Form 10-K describes its caps as limiting the variable rate for a limited, pre-determined period of time, reports paying cap premiums, and notes it is exposed to the credit risk of the cap counterparty.
Freddie Mac's Guide Chapter 11 sets the lender-side rules. The cap provider must be on an approved counterparties list and keep its required rating. The borrower must maintain a cap until the loan is paid in full. If a cap expires before maturity, the borrower makes monthly deposits during the cap's term building to 125 percent of the servicer's estimate of the cost of a replacement cap. If a cap lapses without a replacement, Freddie may apply the default interest rate or use the borrower's payments to buy one.
The first cap is bought at closing. Freddie's Guide Chapter 10 counts the actual cost of the initial cap among permitted closing costs within a total acquisition cost. In a DST, that cost is part of what the offering raises.
A hypothetical shows what the cap covers and what happens if it lapses
Hypothetical figures, rounded. A trust borrows $10,000,000 interest-only at SOFR plus 2.5 points, with a cap at a 3.0 percent SOFR strike. If SOFR is 2.0 percent, interest is 4.5 percent, $450,000 a year, and the cap pays nothing. If SOFR is 4.5 percent, the loan rate is 7.0 percent, $700,000, and the cap pays $150,000, holding net interest at $550,000.
If the cap expires with SOFR at 4.5 percent and the replacement reserve is short, net interest jumps by $150,000 a year. On a trust distributing $400,000, that is more than a third of the distribution. Run your own numbers with your CPA using the offering's loan terms.
A filed DST loan shows the swap alternative and its price
A listed REIT's 2025 Form 10-K describes a DST it formed in November 2025. The trust borrowed $7,710,000 at one-month SOFR plus 2.5 percent, interest-only for a five-year term, and entered an interest rate swap that fixes its rate at 5 percent through the loan's maturity. The trust paid a premium of $417,136 to secure the fixed rate, about 5.4 percent of the loan amount.
A swap matched to maturity removes the expiry problem a shorter cap creates, but it gives up any benefit from falling rates, and the same filing warns that early termination of a hedging contract, for example on an event of default, can require a payment equal to the unrealized loss on the position. The filing also shows the sponsor's operating partnership guaranteeing certain losses and, on the trust's bankruptcy or insolvency, the loan balance, the carve-out structure covered at DST lender documents and carve-outs.
The ruling's ban on refinancing turns every hedge decision into a decision made at closing
The ruling lets the trustee renegotiate debt or take new financing only on the tenant's bankruptcy or insolvency, and Freddie Mac's DST memo lists the trust's inability to refinance at maturity as a lender risk. So the index, spread, cap strike, cap term, replacement reserve and maturity are fixed for the life of your investment.
Ask for each of those terms in writing, the cost of the initial cap or swap, the size of the replacement cap reserve against a current quote, and the distribution at a SOFR one and two points above today's. The coverage arithmetic is at debt service coverage in DSTs, and the reserve side at how much reserve a DST should hold.
Related questions
Do DSTs use floating-rate loans?
Some do. A REIT's 2025 Form 10-K describes a DST loan at one-month SOFR plus 2.5 percent, hedged with a swap to a 5 percent fixed rate.
What happens when a DST's rate cap expires?
Under Freddie Mac's guide the borrower must already have reserved for a replacement cap, building to 125 percent of its estimated cost. If no new cap is in place, the lender may charge the default rate.
Is a cap or a swap better for a DST investor?
A swap matched to the loan's term fixes the rate for the whole hold but forgoes falling-rate savings; a cap keeps the upside of lower rates but covers only its term. Compare the cost of each with the hold period.
Can the DST refinance into a fixed-rate loan if rates rise?
Not while it remains a DST. The ruling bars renegotiating the debt or new financing except on the tenant's bankruptcy or insolvency.
Who pays for the rate cap?
The trust, out of offering proceeds at closing and out of cash flow for replacement cap deposits. Both reduce what reaches investors.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- Rev. Rul. 2004-86 (IRS)
- Form 10-K for 2025 of a listed REIT that began sponsoring DSTs (SEC EDGAR)
- Freddie Mac Multifamily, Conventional Floating-Rate Loan term sheet (April 2026)
- Freddie Mac Multifamily Seller/Servicer Guide, Chapter 11: third-party interest rate cap requirements
- Freddie Mac Multifamily Seller/Servicer Guide, Chapter 10: credit underwriting
- OCC, Comptroller's Handbook: Commercial Real Estate Lending, version 2.0 (March 2022)
- Form 10-K for 2025 of a non-traded industrial REIT with a DST program (SEC EDGAR)
- Freddie Mac Multifamily, Legal FYI: Delaware Statutory Trusts (August 2014)