What to Know About Commercial Loan Refinance

David Cohn
November 4, 2020

If you are new to commercial real estate investing, you have probably looked at other investors and wondered how they managed to grow their CRE portfolios so fast. It’s no secret that commercial properties are expensive.

So how do they manage to buy so many assets? The answer: Commercial mortgage refinance.

This guide will talk about what commercial loan refinancing means, when it makes sense to use it and what benefits it can provide you as an investor.

What is Commercial Loan Refinancing?

“Refinancing” involves replacing a current debt obligation with another, under different terms.

Experienced investors use commercial loan refinancing as a tool for unlocking the equity in their CRE holdings while lowering interest rates and saving money in the long run. Some investors also refinance multiple properties into a single portfolio to increase savings and simplify things.

In general, the more revenue a commercial property makes, the better the refinancing loan terms lenders tend to offer. It’s important to note that commercial loan refinancing terms and conditions are different from those of residential real estate refinance products.

Also, Read “A Beginner’s Guide to Commercial Real Estate Loans”

Commercial Refinance Rates and Terms

In general, interest rates on commercial mortgage refinancing are higher than those imposed on residential mortgage refinancing. That said, owners who occupied the commercial property—as in the case of a multifamily building, for example—may get lower interest rates.

It’s also important to understand that CRE lenders rarely use percentages to refer to interest rates. Instead, they use the jargon “basis points.” The simplest way to understand basis points is to remember that one point is equal to 0.01%. This means that if an interest rate goes down by 25 basis points, it has decreased by 0.25%.

Always shop around with several different lenders before you refinance to your commercial property so you can see the various loan offerings and terms for your project or situation.

It’s also a good idea to consult with a highly experienced commercial mortgage broker. These professionals can do a lot of leg work for you. The best ones can even customize financing solutions that best fit your unique requirements.

Besides, a good commercial mortgage broker can look into the nuances of a refinancing deal that may not be readily obvious—such as how much the lender is making in profit from the agreement, or the number of basis points in the spread, etc. They can make commercial refinance loan products more transparent for you to make a truly informed decision.

When Does It Make Sense to Refinance?

Commercial real estate investors refinance their portfolios—either as a whole or in part—for many reasons. Here are some of them:

1. Generate extra cash on hand

Refinancing a commercial property allows the owner to get tax-free extra cash that can be used for virtually any purpose, from buying a boat to paying for their kids’ college tuition fees.

Many owners also use refinancing to fund new business ventures. It’s a great option if you need extra cash but don’t want to sell the property. With refinancing, you can tap your commercial property equity to secure some cold hard cash when needed.

2. Improve a commercial property

Some commercial investors don’t have enough money left to improve after putting a hefty down payment on a property. Over time, they may want to generate cash to invest back in the real estate asset in the form of improvements, and an excellent way to do that is to refinance the mortgage.

Let’s say that you purchase a building for $8 million and that you didn’t have time to shop around from different lenders because you had to close quickly, accepting the terms offered by the first bank you approached.

After two years, you decide to refinance the building to get better terms and pull out $500,000 in cash that you can then use to invest in improving the property. Once you’ve made powerful add-ons to the asset, you can charge new tenants higher rent.

This enhances the property’s cash flow in the long run, which ultimately improves your net operating income—and this better income will enable you to get better terms should you decide to refinance again later on.

3. Expand your CRE portfolio

Seasoned CRE Investors routinely use commercial loan refinance products to grow their real estate portfolios. This strategy—often called leveraging—has allowed many successful investors to amass fortunes through commercial real estate.

Let’s say that you purchased a 12-unit multifamily apartment in a great location many years ago for 950,000 thousand dollars. You took out a mortgage of $520,000 and paid the rest out of pocket. The property is now worth $3 million.

You can decide to refinance the property, taking out a new mortgage worth $2.52 million and paying off the outstanding balance on your or original loan of $520,000. This essentially leaves you with two million dollars in cash that you can then use to buy another income-generating commercial building.

Let’s say you decide to use the funds to purchase two additional buildings with 19 units each. Let’s say that each building requires a down payment of $1 million.

You have successfully grown your portfolio from 12 to 50 units using the equity from your original investment in this scenario. Refinancing your 12-unit building allowed you to afford two additional commercial properties.

4. Enjoy Lower Interest Rates & Better Loan Terms

Experts say that residential mortgage refinancing makes sense only when the interest rate can be lowered by at least 0.75%. But commercial property refinancing uses a different threshold.

Many seasoned CRE investors say that refinancing a commercial property should only be done if the interest rate can be lowered by at least 2%.

Why? Because there are steep transaction costs involved in commercial refinance loans. The decrease in interest rates should make up for those costs.

A CRE investor may also use refinancing to get better loan terms. For example, property owners with adjustable-rate mortgages might find it wise to refinance into a more stable fixed-rate mortgage to give their investment portfolio some predictability over the long term.

5. Avoid an Upcoming Balloon Payment

This is another popular reason for CRE refinancing. Unlike residential mortgages usually amortized over a long period—like 30 years—commercial property loans have varying term lengths. For example, short-term commercial loans like construction loans are typically issued for three years (sometimes less). The terms on long-term CRE loans, on the other hand, range between 5 to 20 years.

The unique thing about commercial loans is that they usually require a large balloon payment at the end of the term. When the loan matures, the borrower would have repaid only a small fraction of the principal. The remaining debt becomes due right away. This last “balloon” payment is usually substantial.

Investors who want to dodge this balloon payment can refinance to replace the original loan with a new loan, which effectively pays off the original loan. This can save them from having to make a balloon payment out of pocket. Refinancing essentially resets the clock on a commercial mortgage, often under vastly different terms.

The five items discussed above are just some of the major reasons why CRE investors

of all sizes—from nationally-renowned commercial investment trusts to mom-and-pop landlords—refinance commercial property.

Types of Commercial Refinance Loans

Suppose you are interested in enjoying the benefits of commercial loan refinancing. In that case, you first need to understand the different options available so you can carefully consider which one is best for you.

Conventional commercial refinances loans

Also called traditional commercial refinancing; these loans are best used by investors seeking to lower the interest rates they are paying on their properties. The new loan terms may end up looking similar to that of the original mortgage, but the interest rates should be markedly lower.

Commercial cash-out refinancing

This type of refinancing allows borrowers to tap their equity on their properties to get cash, as described by its name. Only CRE owners with significant equity (at least 30%) can qualify for commercial cash-out refinancing.

Many investors use this kind of loan to borrow against the equity they have amassed over the years and use the proceeds to improve the property or help fund fit-outs for tenants.

Commercial bridge loans

Commercial bridge loans are short-term loans best used to “bridge” the gap until the borrower can secure long-term financing for the property or sell it for a profit. Because of their short-term nature, bridge loans typically have 2-year terms (sometimes less).

These loans are usually structured as “interest-only,” with large balloon payments at the end of the term. They command higher premiums—around 1 to 3 percentage points higher, in general, compared to average market rates. They are widely used to renovate commercial properties that don’t qualify for traditional mortgages.

Types of Commercial Refinance Lenders

Traditional banks offer refinancing solutions for commercial real estate, but they’re not the only ones that do this. Several other lenders also provide CRE refinancing loans. If you’re interested in shopping for a loan, here are some options to consider:

Traditional commercial banks

Perhaps the most straightforward way to seek refinancing for commercial real estate is to go to a traditional banking institution such as Wells Fargo, JPMorgan Chase, KeyBank, or Bank of America. These are just some of the many traditional commercial banks that can help you refinance your CRE asset.

They generally offer similar terms, with a difference of just a few basis points. Some of them offer unique refinancing programs for repeat clients or long-time clients, so it’s a good idea to start with banks where you regularly do business and then compare their offers with competing banks.

Hard money lenders

Some investors turn to private hard money lenders when they can’t secure refinancing through traditional banking institutions. There are many hard money lenders out there, some specializing in specific risk portfolios and loan sizes.

Hard money tends to have higher interest rates and less favorable terms than those offered by traditional banks. However, they offer fast funding—usually closing in 10 days or less—so they are beneficial for borrowers who need cash quickly.

Small Business Administration

The SBA offers refinancing products to small business owners who own the commercial property where they operate their business. It’s called the SBA 504 loan, which can be tailored to different requirements. They are widely used by business owners who want to avoid upcoming balloon payments and those who want lower interest rates.

An SBA 504 loan offers low fixed rates and terms of 10 or 20 years, fully amortized. Commercial banks typically provide first mortgage loans while the SBA provides second mortgages (via a local community development corporation) with up to 90% LTV. Borrowers usually only need a down payment of 10%, which is easily covered by their existing equity in most cases.

Community banks

These banks operate much like traditional banking institutions except that they focus on commercial real estate assets located within a specific area.

Some are aggressive in their approach to CRE investing because they have hyper-local, expert-level knowledge and experience in that area’s real estate market.

Some examples of community banks that offer commercial refinancing include First Foundation Bank (Los Angeles), Dime Community Bank (New York City), and East Boston Savings Bank (Boston).

Commercial mortgage-backed securities

Better known as CMBS loans or conduit loans, these types of refinancing have very low to zero cash-out restrictions, so it is quite popular with investors who want to extract equity from their commercial properties.

A typical CMBS loan will have a maximum LTV of 75%. So for a property that is worth $20 million with a remaining $8 million in loan balance, the owner can take CMBS refinancing with a 75% LTV to generate approximately $3 million.

These loans are packaged and sold by commercial banks, investment banks, “conduit” lenders, or banks’ syndicates.

Crowdfunded loans

This new and somewhat atypical refinancing strategy has grown in popularity over the recent years, as several crowdfunding platforms hit the mainstream. Platforms such as CrowdStreet, RealCrowd, and Patch of Land help investors “crowdsource” money to refinance their CRE projects.

Getting Professional Advice on Commercial Loan Refinance

If you’re interested in refinancing a commercial real estate property but don’t know where to start, it’s best to talk to a CRE financing consultant. These professionals have a vast network of lenders—many of whom you probably don’t even know about. They are licensed to help you with your application, essentially taking the stress off your shoulders.

They can also steer you away from the wrong loan products and warn you of onerous terms that may be buried in certain deals, essentially protecting your best interests.

Working with commercial financing advisors is especially advantageous for borrowers whose credit history is less pristine. If this sounds like you, you will likely be able to secure more favorable loan options with a consultant’s help.

Need help? You can count on us here at Capital Investor. We are headquartered in Rockville, Maryland but have offices and representatives all over the US. Our commercial real estate investment advisory firm serves clients nationwide.

We specialize in offering commercial loan solutions that are tailored to your needs and situation. We also have access to loans that are not available through traditional lenders.

With Capital Investors Direct, you can expect fast closing so you can quickly act on a deal before a competitor does. We can also find you the best interest rates (as low as 7%).

Our refinancing application process is simple, and our loan structures are highly customizable. We can help refinance commercial properties of all sizes. Talk to us today to explore your options.

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