Commercial Real Estate Refinance – A Complete Guide


Real estate acquisitions and investments are money spinners that help investors earn profits and margins as property prices move up. However, the investment that is required for a holding stake in the property is substantial.

Businesses and individuals into commercial real estate investments seem to increase their portfolio of holdings over a period of time without actually disposing of an existing property. This may sound strange considering the number of substantial investments required for properties.

However, most of the commercial real estate funding is through a prudent loan management strategy where the borrower relies on refinancing to extract equity in a property. This is then used to fund the next acquisition.

The chain of investments helps investors to expand the portfolio and build up sizeable assets. As the value grows over a period of time, the investor either disposes off the property or continues to enjoy the earnings from the property. In a nutshell, this is how the cycle of investments and expansion works in commercial real estate.

Here is the complete guide to commercial property refinance, dwelling on every aspect you need to know about the processes involved, the rates, the advantages, and the available options.

What is Commercial Loan Refinance?

Commercial real estate refinance is not the equivalent of residential property refinancing as the modalities, and the purpose is the opposites of each other. The whole idea of commercial property refinances to gain access to the investor’s equity value in the property and use the same for investments in other properties or purposes as deemed fit by the investor. It hinges to a great extent on the property’s value, or rather the difference in the value of the property from the time of original acquisition. Another way of looking at this is the income generation capacity of the property.

A property that has increased its net operating income value is considered sound to refinance. While commercial property loans and residential property loans differ in terms of loan tenure, there are no laid down rules that prohibit a loan tenure from extending into the long term. While most of the loans are typically in the range of 7 years, come are known to extend for longer durations. This is because of the nature of the property and its holding.

For instance, a residential property owner/prospective owner generally intends to stay in the property for as long as possible, and it becomes a lifelong investment. Hence the duration extends for as long as 30 years typically. However, in the case of commercial properties, the intent is not to stay in the property forever.

The intent is to earn from the property in the shortest possible time and either enjoy the profits or use the profits for expansion. It, therefore, makes more sense for an investor of commercial real estate to have shorter liabilities. Additionally, an investment that is fettered to a long term liability will eat into the profits by way of interest, which does not qualify it as a prudent business choice.

Why is commercial property refinance a popular option?

Multiple reasons contribute to commercial property refinancing becoming a popular choice. Some of the reasons are pre-planned strategies of investors who crunch numbers and come up with formulas that work to their benefit through the refinancing route.

Some of the reasons are unplanned, mainly the product of market trends and conditions that force an investor to end up refinancing as the only way forward. The single biggest reason for refinance is the repayment mode of commercial properties. The balloon payment at the end of the loan tenure is effectively the main reason behind most investors’ refinancing route.

For instance, a property on the market may appear to be a sound choice due to demand and the attractive cost. To quickly take ownership of the property, investors take out a commercial property loan, put in down payment, and take possession of the property. There is no other way of procuring high-value property unless the investor ties up with other institutional investors.

The repayment of the loan amount is often from the rental income of the property. However, as the loan comes to the end of its tenure, the investor needs to make arrangements for the balloon payment’s repayment. This could be as much as 85% of the loan amount. Though it does not necessarily have to be 85% of the loan amount, the maximum is often 85% of the loan amount.

It is to be borne in mind that the loan amount is different from the purchase’s actual value, which includes the down payment and the loan amount.

As the balloon payment looms towards the end of the loan tenure, the investor chooses the only way out – refinancing. This helps to take over the repayment burden while also marginally reducing the cost of repayment by way of lowered interest rates. This is one of the most common reasons for the refinancing of commercial real estate. The second most popular reason is to extract equity from the property.

In other words, most property values are bound to increase either substantially or marginally over a period of time. The value of the property from the time it was purchased will differ from the property’s value many years down the lane. This difference in value is changed equity of the investor, which can then be extracted to the investors’ benefit. The investor can use the change in value to extract liquidity and use it for any purpose, including acquiring other assets.

Now that you have a broad perspective of commercial property refinance, it is time to look at the various stakeholders or types of institutions classified as lenders for commercial property refinance.

Types of lenders – commercial property refinance

There are five different broad categories of commercial property refinance lenders.

(1) Traditional Banks,

(2) Government-backed institutions,

(3) Insurance Companies,

(4) CMBS – also known as Asset-Backed Trusts or Hard Money Lenders

(5) GSE backed mortgage funds.

  • Traditional Banks – By far, the most popular and common among the various categories of lenders across all categories of loans, traditional banks are the pillars of funding, managing, and funding most of the assets. Traditional banks are often the first choice of borrowers when it comes to borrowing, including refinancing. However, traditional banks lose some of the sheens compared with other entities because of the regulation of centric processes. Banks governed by various regulations to protect the funds at the bank’s disposal from turning into non-performing assets. Consequently, the processes may appear to be a bit more tedious than that of other entities. Banks typically offer shorter loan tenures, though it is not mandatory and is entirely at the discretion of the bank and the various criteria used to determine the suitability/risks associated with a loan. One reason for investors choosing banks over other entities is the existing relationship with the bank. Most investors and institutions hold accounts for transactions and may or may not have availed a bank loan. This forges a relationship with the bank, which can then be used to the investor’s advantage.
  • CMBS or Hard Money Lenders

are the next best investors’ options when Banks turn down requests for refinancing options. These categories of lenders have more relaxed criteria when extending refinance to a borrower. This makes it a viable option for borrowers who are unable to avail refinancing from banks. However, the rates of interest and the terms of the loan are not close to the favorable terms and rates offered by traditional banks. The tradeoff here is the easy access to funds through refinancing. For the quick access to funds, investors end up paying more as interest and need to be able to clear the loan in a shorter period of time, failing which the lien may be exercised.

  • Government-Backed Institutions such as SBA loans are a good choice when it comes to repaying loans. This applies to balloon payments at the end of loan tenures for commercial properties and targets small business owners. The attractive options from these loans are the lower interest rates, and the amortized extended loan tenure. The option is good and works to the advantage of the borrower on multiple fronts. However, this is intended for small business owners, and this may preclude certain categories of institutions and investors from availing this option.

Types of commercial property loans

It is essential to know a little more about commercial property loans. Commercial property mortgages may extend to as much as 30 years; this is not regarded as the best option from an investor’s point of view. Some of the more popular options available include –

  • commercial bridge loans,
  • hard money loans,
  • CDC/SBA 504A loan, and
  • SBA 7(a) Loan.

Depending on the type of loan that an investor has opted for, the financed amount could be as much as 90% of the property’s price, with tenure ranging from six months up to 25 years. Various loan options mentioned above are suitable for different needs and can be used with maximum advantage. The upper limit of the loan amount also differs from product to product and depends on the institution that is extending the loan.

Types of Commercial Property Refinance

There are different types of commercial property refinance options available for investors.

  • Traditional Commercial Refinance – These are the most common types of refinancing for commercial property. The primary reason for looking at this option is to reduce the interest rates of existing mortgages. Most investors do not have a choice when it comes to the first mortgage. For instance, the rates of interest at the time of availing a mortgage may have been high, or there may have been a pressing need to go with the fastest available option to get hold of the property. The option of reducing the interest rates is available through the traditional commercial property to refinance route. The main difference between the first mortgage and the refinance is mostly limited to interest rate, which is marginally or considerably lower.
  • Commercial Cash-Out Refinance – This is the equity extracting model, wherein the investor looks for a method to withdraw cash from the venture. The difference in value from the time of purchase to the prevailing rates is the criteria to determine the cash-out. This is a good and prudent option and is typically used when the investor needs funds. This could include additional investments, or it could be to improve the existing property or simply enjoy the fruits of investment. This permits the investor to hold on to the property without diluting stake, while still withdrawing an amount that could be the initial down payment on the property. Here, it is important to understand that the interest rates are unlike traditional commercial real estate refinancing. The interest rates could be higher than the original mortgage or lower than the original mortgage. As the purpose of cash-out refinances is to gain access to cash and not to reduce interest rates, the investor may overlook or accept this tradeoff.

How to apply for commercial property refinance

There are requirements for commercial property refinance that need to be fulfilled for an investor or entity to avail. Depending on the type of lender, the requirements differ, making it necessary for the borrower to meet the desired criteria.

Additionally, the loan amount and the loan tenure also have a bearing on the assessment criteria used, and this will mandate the need for additional documents and processes.

 Minimum documentation that is common to most lender types for commercial property refinance include the following – (1) Records of the finances of the business entity (2) Records of Assets (3) Records of known liabilities (4) Complete details of stakeholders in the business (5) Bank statements and (6) Tax returns of the individual(s) as well as the entity.

The prospective borrower needs to have the above documents to apply for and move the process of refinancing forward. The actual process itself involves an assessment that is similar to that of residential loans.

Before the application’s processing, the applicant is evaluated on various criteria to determine the risks involved in lending. This includes a detailed assessment of assets, liabilities, and history of repaying credit, on clearing the initial round of pre-qualification, the application moves to the next stage of vetting, which includes in-depth scrutiny of tax-related documents and filings that indicate the business entity’s financial health. This will help the lender determine if the loan will end up as a non-performing asset or if the borrower has a history of repaying the debt on time.

Document scrutiny helps understand the stability of the business that seeks refinancing of investment. The applicant’s credit history, the available collateral, the number of holdings, and collateral are all various considerations that determine if a loan can be extended or not. Remember, investors with mortgages in more than a certain number of commercial properties are automatically ineligible for refinancing.

On submission of the relevant documents, the process moves to the underwriting stage, where it is finally approved or rejected. This is based on all the inputs – furnished by the borrower and the inputs gathered by the lender. The combination of all the inputs and information results in either acceptance or rejection of the application.

The entire process could take as long as three months, depending on the amount in consideration and the lender. Most borrowers typically launch the refinance application process at least one year before the end of the original mortgage. This gives the borrower adequate time to choose the right lender and process an application.

It is essential to have at least two or three lenders shortlisted for the refinance as rejection by one lender will require a full repeat of the application process. A good backup option is the best way forward, especially considering that the amount in question will determine the mortgaged property’s fate.

Overview of commercial real estate loan interest rates and tenure

Commercial mortgages and refinance rates are typically higher than that of residential property refinance and mortgages. This is an industry-standard and is associated with various parameters – including the earning potential of commercial properties. Owner-occupied commercial properties have a low rental, and this applies to those properties that have multiple dwelling units where the owner resides/occupies one unit. In contrast, others are let out for rent.

There are various market-driven forces at play when calculating the rate of interest for commercial property refinance. The borrower’s eligibility also determines repayment, and it is, therefore, wrong to assume one rate as the standard for all refinance. This is assessed based on various criteria and inputs.

It is reasonable not to expect more than 85% of the total value, which depends on the borrower’s credit score and business stability. The supporting documents, appraisal of the property, and independent verification of the documents help the underwriter decide the amount that can be extended as refinancing.

Advantage and use cases of Commercial real estate refinance

Commercial real estate can be a sound decision on the part of investors, depending on its use. In certain cases, investors are left with no option but to choose the refinance route to manage or resolve a problem. For instance, balloon payments can be a huge burden on investors.

The prospect of having to repay a sizeable chunk of the loan in one single tranche is something that most investors would be unable to accomplish. This leaves investors with no other option than choosing to refinance.

Investors whose properties have witnessed a significant increase in value can maximize the potential and use refinancing as an option to increase the value further. For instance, the funds from a refinance can be used to extend the property or make renovations that can help the property earn more than the existing rentals. Most properties earn an average of 7% of the value of the property as rentals. This is the accepted industry average.

Any property that earns less than 7% of the value is not considered a good investment. Owners of properties that fetch more than 7% can use it to their advantage and secure refinance to use the funds and extend the property or make renovations that will increase the property’s earning capacity.

Investors grappling with balloon payments find refinancing to be the only way to extend the loan tenure and hope that the extra tenure will help sort out issues. Investors choose balloon repayments with the hope of earning in time to make the bulk repayment. However, when things do not play out as scripted, it becomes necessary for the investors to choose to refinance.

The lowering of interest rate is another reason for refinancing. Acquisitions take place with available resources or loans that are extended at the time of acquiring the property. This may not have been the best deal at the time but may have effectively been the only suitable or eligible option. Refinance helps to tweak the conditions in a manner that makes the terms more favorable. The lowering of interest rates and restructuring loan repayment tenure gives investors more freedom to work out the best option.

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