Refinancing a Commercial Property - Everything You Need to Know

David Cohn
Apr 15, 2021

Some commercial real estate owners choose to refinance their commercial mortgages to enjoy better interest rates, get new loan terms, or leverage the equity they have built in the asset.

Are you also thinking of refinancing your commercial building? Here are all the basics you need to know.

What does ‘refinancing’ a commercial property mean?

Commercial real estate refers to properties that house businesses and are primarily used to generate income.

Some examples include industrial spaces, retail properties, hotels, office buildings, and the like.

Sizeable residential apartment buildings are also categorized as commercial.

At its core, commercial property refinancing works similarly to residential property refinancing. It involves taking out a new loan and using the proceeds to pay off the existing one.

Borrowers typically choose to refinance if they can get lower interest rates or qualify for better terms.

Some borrowers also want to tap their equity in the property to improve their buildings or buy new commercial properties and grow their portfolio.

Potential advantages of refinancing a commercial property

1. Enjoy lower monthly payments

This is the main reason why borrowers choose refinancing. This can be achieved by securing a lower interest rate than the one you currently have.

2. Secure better loan terms

Making the loan repayment term shorter or longer may also be beneficial for commercial real estate owners. For instance, you can refinance from an adjustable-rate loan to a fixed-rate loan if you want more predictability and security should the rate go up.

3. Avoid a large balloon payment

Large lump-sum balloon payments can be a burden for some commercial real estate owners. Refinancing can help you avoid it in some cases.

4. Get cash

A cash-out refinance lets you borrow money tax-free. Many commercial lenders (including conventional banks) allow borrowers to cash out as much as 75% of their property’s current valuation. This is a tangible way for business owners to tap their equity if they need cash to improve the property or add more commercial real estate assets to their portfolio.

Cons of commercial property refinancing

  1. Hefty closing costs

Remember those closing costs you had to pay when you took out your commercial mortgage for the first time? You’ll have to pay them again. So before you choose to refinance, make sure that the savings you can get from your new loan outweigh the expenses associated with getting a new loan.

  1. Restrictions

You can refinance not all CRE properties. As of 2020, for example, you cannot refinance existing SBA 504 loans. Be sure to check with your lender before you make any plans.

  1. Prepayment penalty

Some banks and even the SBA charge a penalty for borrowers who want to pay off their loans early. This can further add to the costs of refinancing.

Types of commercial property refinancing

Now that you understand the advantages and disadvantages of a commercial property refinance, it’s time to learn about the different types of commercial loan refinancing programs.

  1. Conventional commercial refinancing

The government does not back conventional loans. They’re issued mainly by traditional banks and mortgage lenders.

There are no specific loan limits, but most lenders allow borrowers to get a certain percentage of the collateral property’s value and allow an LTV ratio of between 65% and 75%.

  1. Government-backed refinancing

These loans are backed by government agencies like the USDA or the SBA.

To refinance from another loan into an SBA loan, you need to show documentation that you have paid your monthly mortgage payments on time for the last 36 months (or longer).

The SBA can deny your refinancing request for reasons they deem ineligible, such that if you are trying to avoid a balloon payment.

The USDA only refinances loans for properties that are located in rural areas. The borrower also needs to be a US citizen or show a permanent residency status.

  1. Commercial cash-out refinancing

A commercial cash-out refinance loan lets you swap your existing mortgage with a new loan by borrowing a higher amount than what you currently owe on your commercial property.

The difference between your new loan amount and the amount you currently owe is paid to you at closing, in cash.

You can use the money as you see fit, but some lenders have restrictions on how the funds can be used. This type of refinancing is best suited for borrowers who have already built up a good amount of equity in their property (at least 25%).

Commercial mortgage refinancing requirements

The actual requirements will vary depending on the lender and the type of commercial refinancing loan you need. However, most lenders will require to see the following:

  1. Your business credit score - The SBA requires a minimum FICO SBSS (Small Business Scoring Service) score of 155, but there are exceptions.
  1. Net operating income - How much does the property earn minus the costs of its operating expenses? The greater the net operating income, the better your chances of getting approved for refinancing. Minimums will vary by loan program and by a lender and the size of the property and type of business.
  1. Debt service coverage ratio - This ratio shows if a business has enough cash flow to pay its debts. A higher than one indicates that a firm generates enough revenue to pay for its loans comfortably. To lower their risks, lenders typically require a minimum debt service coverage ratio of 1.2 to 1.5.
  1. Operating history - You need to demonstrate that your business has been operating steadily for at least two years.
  1. Personal and business documentation - It would be best to show your personal and business tax returns, personal and business bank accounts, company operating statements, etc. If you’re a landlord, the lender may ask you to show your schedule of CRE holdings and rent rolls.

Costs of refinancing a commercial property

It’s essential to understand the fees associated with refinancing so you can decide if it’s worth the effort in your case. Here are the most common costs borrowers have to pay when refinancing CRE properties, and they vary per lender:

  • Prepayment penalties
  • Guaranty fees
  • Credit report fees
  • Application fees (needs to be paid even if your application is not approved)
  • Origination fees (usually at least 1% of the loan amount)
  • Appraisal fees (anywhere from $2000 to $4000 depending on the location of the property and other factors)

Commercial mortgage refinancing rates

In 2020, commercial mortgage refinancing loan rates ranged from 3% to 12%.

Your actual rate will depend on the refinance loan you choose, the type of property you want to refinance, and your qualifications as a borrower.

Not sure if refinancing your commercial mortgage is the best move given your circumstances?

Talk to a commercial mortgage expert to understand your options.