There are a lot of misconceptions about refinancing in commercial real estate because borrowers see only the new lower monthly payment and don’t account for the cost of paying interest over a longer repayment period.
At its simplest, refinancing means replacing your current commercial property loan with a new one to:
- reduce your borrowing costs by securing a lower interest rate
- release equity from the property, meaning borrowing against the value you have built up
- pay off a balloon payment
Important: Refinancing is not automatically worthwhile despite those potential benefits.
The new loan may also extend your debt far beyond the period you plan to own the property. The savings may not justify the closing costs.
Prepayment penalties may be so large that they outweigh the benefits of securing better terms.
So before applying for refinancing, you need to know exactly what you stand to gain after accounting for the full costs of replacing the loan.
Why refinance a commercial property?
In CRE, refinancing is usually used for one of four reasons:
1. Securing a lower interest rate
Refinancing at a lower rate can help you reduce your monthly debt payments.
That said, if the new loan carries substantial fees or resets the repayment schedule over a longer period, you may end up spending more to repay the debt overall.
2. Taking cash out of the property
Has the property increased in value and/or have you paid down a significant portion of the original loan?
You may be able to borrow against the equity through cash-out refinancing, and then use that money to fund renovations or even buy another property.
Of course, taking cash out increases the property’s debt. So before you proceed, confirm that the building’s net operating income can cover the larger payments even if rents decline during a weaker leasing period.
3. Extending the loan term
Refinancing may spread the remaining debt over more years, which may lower the payments you need to make in the near term.
This can give you more time to increase occupancy and/or prepare the property for sale, but it also keeps you in debt longer and increases the total interest you pay over the life of the loan.
That’s why you need to review how long you expect to own the property before extending the debt.
4. Exiting a maturing or balloon loan
Do you have to pay the remaining principal on your current loan in one lump sum?
You may be able to use refinancing to roll the outstanding debt into a new loan.
However, it’s important to explore the available loan structures early because the new lender may value the property lower than you expected.
You’ll need time to secure additional cash to pay down the difference.
When is the “right” time to refinance a commercial property?
Just because the advertised rates are lower doesn’t automatically mean that it makes financial sense for you to apply for refinancing.
Look at your current loan:
- How much do you still owe?
- When will the loan mature?
- Would you need to pay a prepayment penalty if you refinanced it now?
Then look into the property’s current state:
- Has its income improved?
- Has its value increased?
- Does it have more/stronger tenants?
Lenders usually base their decision on what the property is earning now, so you may be better off waiting if there has been a temporary drop in the property’s income.
It might also be better to wait if several major leases are close to expiring. You may get a higher valuation if occupancy improves first.
How do you calculate the full cost of refinancing a commercial property?
1. Request a written payoff statement from your current lender and check if there are any exit penalties.
Contact your current lender directly and ask for an official payoff statement that explicitly details any prepayment penalties that you may need to pay if you decide to refinance. Those exit costs will raise your upfront cost.
2. Get itemized cost estimates from prospective lenders.
Lower interest rates can disguise what it costs to replace the debt, but be careful: they don’t show you the full picture.
Ask every lender you’re considering to provide a full itemized estimate in exact dollar amounts (not just percentages) covering:
- appraisal fees
- origination and lender fees
- legal fees
- third-party closing costs
3. Tally your total upfront refinancing costs.
Combine all the fees from Step 2 plus any prepayment penalty from Step 1.
4. Calculate your monthly payment savings
Subtract your proposed new monthly payment from your current monthly payment.
5. Run the break-even calculation.
Divide your total upfront costs by your monthly savings to find out how many months it will take to recover your investment.If your total costs are $150,000 and your new loan saves you $10,000/month, your break-even point is 15 months.
6. Compare your break-even timeframe with how long you plan to keep the commercial property.
If you intend to keep the property longer than break-even, refinancing makes financial sense.
But if you intend to sell before break-even, you will lose money on the transaction unless the refinance achieves a critical non-financial goal (like eliminating immediate maturity risk or funding value-add renovations).
Important: If you plan to pull cash out or change your loan term/amortization period, it won’t be enough to run simple monthly payment comparisons.
Calculate the total cash spent over your planned holding period (including upfront fees, all monthly payments, and the final loan balance at exit) and choose the option with the lower net cost.
What do lenders look at when assessing a loan application for commercial property refinancing?
Lenders will assess your refinancing request as a new loan application.
You have to show that the property earns enough to cover the new debt and that your finances meet the lender’s requirements, just like you would when you apply for any other type of commercial property financing.
Here’s what lenders will look at:
- Loan purpose – The lender will ask why you want to refinance and how you will use any cash proceeds.
- The property’s cash flow – The lender will calculate the property’s NOI and compare it with the proposed annual debt payments to produce the DSCR. The higher the DSCR, the more room the property has to absorb a drop in income and the more willing the lender may be to approve the requested amount. Read our guide to DSCR in commercial real estate if you need further information.
- Property value and LTV – The lender will compare the new loan amount with the property’s appraised value. If the appraisal is low, you may have to bring more cash to closing. Check out our guide to LTV in commercial real estate for a deeper dive.
- Borrower credit and liquidity – Some lenders will also review your personal credit and business credit. Be prepared to show detailed records of your available cash and existing liabilities. If you can demonstrate that you’ve been managing the property profitably for a long time, the lender may view the deal as less risky. It will also help to show that you have enough reserves to carry the property should there be unplanned repairs or temporary income interruptions.
- Property condition and tenancy – Expect the lender to thoroughly look into the current occupancy trend and the quality and duration of the current leases. Have you deferred some key maintenance tasks? That may reduce the appraised value or prompt the lender to require a repair reserve.
What are the common refinancing mistakes commercial property investors make and how do I avoid them?
Mistake: Fixating on the lower interest rate
A new loan may still be expensive — even if it has a lower rate — if you have to refinance again soon or pay a large penalty to repay it early.
Compare what each loan will actually cost during the years you expect to keep it.
Mistake: Ignoring the current prepayment penalty
Find out exactly how much it will cost to exit your current loan before you refinance.
If the prepayment penalty is too large, it may wipe out the savings you were expecting from the lower rate. The refinance might not be worth doing.
Mistake: Assuming that the property has increased in value
Don’t assume that the property will be valued as highly as you expect. If the appraisal comes in lower, the lender may still be willing to proceed, but they will lend less.
Mistake: Extending the debt without checking total interest
Stretching the loan over more years can make the payments easier to manage, but you may pay more interest overall.
So don’t compare the monthly payments alone — check how much interest each loan would cost during the time you expect to keep it.
Mistake: Waiting until the existing loan is about to mature before exploring refinancing options
If you need to cover a balloon payment and wait until the last minute to apply for refinancing, you may be forced into a situation of having to accept worse terms because you have too little time to compare lenders.
Mistake: Accepting a term sheet without checking the conditions
Check the term sheet for every condition that could change how much you actually receive.
In some cases, the quoted loan amount is not guaranteed.
The lender may reduce the amount before closing if the appraisal comes in low or the property’s income does not meet the required DSCR.
The bottom line: Should you refinance?
Refinancing may be a good idea if the savings are measurable and realistic after fees and penalties, or if it solves a looming maturity.
It may also work in your favor if you have a solid plan for using the released equity to improve and strengthen the property.
But it might not make sense if the closing costs cancel out the expected savings. Run the numbers over your actual ownership period. Judge the refinance based on the full loan terms rather than the advertised rate.
