It’s not uncommon to meet someone in the commercial real estate industry and wonder “How on earth have they grown their portfolio so quickly?”

After all, commercial real estate is an expensive investment.

You might wonder how they came up with the up-front capital to buy the property, and how they can afford the monthly mortgage payments?

Commercial mortgage refinancing has a lot to do with it.

Here, we’ll provide an overview of commercial loan refinancing, including what it entails, who utilizes it most often, and the benefits it provides owners.

Commercial Loan Refinancing Defined

Refinancing commercial real estate is much different than the process of refinancing residential properties purchased for personal use and enjoyment.

Commercial real estate is intended to generate income, and that income is what underlies the value of the property. Generally, the more revenue a property generates, the more favorable are the loan terms offered by lenders.

Investors place debt on a property at the time of purchase, but there are several reasons why they almost always end up refinancing down the line.

Unlike residential real estate, in which mortgages typically amortize over a 30-year period, commercial loans can have very different term lengths.

Short-term loans are usually issued for three years or less. These are often construction loans used to build or significantly improve a property.

Long-term loans on the other hand can vary widely in length, but generally have terms between 5 and 20 years. Similar to residential loans, long-term commercial loans can even amortize over a 30-year period.

Unlike residential loans however, commercial loans generally require a balloon payment at the end. You still pay incrementally as though you were paying over a 30-year period, but when the loan matures (say, in 5 years), you would have only paid down a fraction of the principal and the rest of the loan amount owed becomes due immediately. That last payment is typically very, very high.

Refinancing is a way to replace the original loan on a property with a new loan.

For instance, as we discussed above, if a balloon payment were about to become due, you might want to refinance the property.

The new loan will effectively pay off the old loan (which will save you from having to pay the upcoming balloon payment out of pocket), and “reset” the clock on the mortgage – often under different terms and conditions.

This is just one of the reasons why investment property owners of all sizes, from the mom-and-pop landlord to nationally renowned real estate investment trusts, refinance commercial property. We will discuss the benefits of refinancing in more detail shortly.

What’s important to understand here is that commercial loans often come with different terms and conditions than residential real estate mortgages.

Commercial Refinance Loan Terms and Rates

Commercial loan interest rates are typically higher than residential mortgage rates. In the off-case scenario that the owner occupies the commercial property (for example, if it is a multifamily rental property), the interest rate may be a bit lower.

It is worth mentioning that commercial real estate lenders usually don’t refer to interest rates as percentages. Instead, you may hear a lender use the term “basis points.” A basis point is equal to 0.01%. So if a rate goes up or down 25 basis points, it means that it has increased or decreased by .25%.

Before you refinance commercial property, it’s a good idea to shop around with several lenders in order to understand the various loan programs and terms available for your situation. Additionally, it may be helpful to work with a commercial mortgage broker. Commercial mortgage brokers can do a lot of the heavy lifting for you, and will shop around with different lenders to find the best terms for your loan.

A commercial broker can also investigate the nuances of a refinance deal that you may not fully understand, for example how many basis points are in the spread, or the lender’s profit. Their services will provide more transparency for you as the borrower.

When & Why Is Refinancing Useful?

There are many reasons why an investor may want to refinance their commercial real estate, either in part or as an entire portfolio. Let’s discuss some of the more notable ones in detail.

1. Extra Cash On Hand

Refinancing commercial property allows owners to obtain extra cash. Not only is this money considered tax-free, but it can be used for any purpose.

Maybe they have kids going to college, or they just want to buy a boat. Whatever the case, property owners can fund these ventures by refinancing an existing mortgage.

A cash-out refinance provides a great alternative for an owner who might otherwise consider selling the property. Owners can tap the equity of their commercial real estate in order to secure cash on hand when needed.

Reonomy Commercial Property Refinance Apartment Building

2. Invest in Property Improvements

Someone who has just put a hefty down payment on a commercial loan may not have additional funds to also make property improvements. Over time, as the owner collects rent and pays down the original mortgage, they may decide to refinance the loan as a way of generating cash to invest back in the property.

Case in point: an investor purchases a multi-building portfolio for $80 million. Because they need to close quickly, they do not shop around and accept the loan terms from the first available bank.

Within two years, a handful of tenants turn over at the complex. The owner decides to refinance the property. In addition to getting better terms, they are able to pull out $5 million in cash which can be used to invest in the buildings.

Now that the investor has made significant improvements to the property, they are able to charge any new tenants higher rent.

In the long run, this move will improve the property’s cash flow, which in turn will improve the net operating income (NOI). The better the NOI, the better the terms the owner will be able to get if they decide to refinance yet again down the line.

3. Expand Your Investment Portfolio

It’s very common for owners to refinance commercial property as a mechanism for growing their real estate portfolios. This is how so many people have amassed fortunes through real estate. It’s what’s referred to as “leverage.”

Let’s look at a real-life example.

Investor Tom owns a 12-unit apartment building in Boston’s Fenway neighborhood. He purchased the property in 1990 and therefore, had a very low cost basis by today’s standards.

By 2001, the property he purchased for $950,000 was worth $3 million. So Tom refinanced the property.

He took out a new mortgage of 2.52 million and paid off the outstanding balance on the original loan ($520,000). This gave him $2 million in cash on hand that he could use to purchase another piece of commercial property.

Tom decided to use that money to fund the acquisition of two additional 19-unit properties – each of which required approximately $1 million for the down payment.

His portfolio grew from 12 units to 50 units by leveraging the equity from his original investment. Tom wouldn’t have been able to afford the two additional properties, had he not refinanced the 12-unit apartment building.

One thing that Tom could’ve done as well, would be to pair his cash on hand with Reonomy in order to prospect and find a list of property owners off-market that are likely looking to sell.

Reonomy has owner details and contact information, sales and debt history, current tenants, building and lot information, and more on over 50 million commercial properties nationwide.

Additionally, property mortgage history, lender data, and sales history help you identify refinance opportunities in any market.

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4. Lower Interest Rates

As a general rule of thumb, homeowners should consider refinancing when they can lower their interest rate by 0.75% to 1% or more. There’s a different threshold used in commercial real estate.

Industry standard is to only refinance commercial property when you can lower your interest rate by 2% or more, given the steep transaction costs of commercial refinance loans (more on that to come).

5. More Favorable Loan Terms

An investor may also want to refinance commercial property in order to obtain more favorable loan terms.

For instance, a property owner with an adjustable-rate mortgage may want to refinance into a fixed-rate mortgage which can provide more predictability in the long term.

Similarly, someone might refinance commercial real estate to dodge an upcoming balloon payment as discussed above.

Commercial Refinance Loan Types

Before investors can take advantage of any of the benefits of refinancing, they need to carefully consider the different mortgage loan types available for commercial real estate.

Traditional Commercial Refinance Loans

The most common refinancing loan type is a traditional commercial loan. These loans are generally used to refinance into a lower rate mortgage. The terms of the loan may look similar to the original mortgage placed on the property—but at a lower interest rate.

Commercial Cash Out Refinance Loans

A commercial cash out refinance loan allows the borrower to tap the equity of their property to take cash out, as described above. In order to qualify for a commercial cash out refinance loan, the owner must have significant equity.

Most banks require the owner to have at least 30% equity in the property after the cash is taken out. A commercial cash out loan is often used when an investor wants to borrow against their equity and use the money to make property improvements or to assist with tenant fit-outs.

It is worth noting that sometimes an owner may end up taking a commercial cash out refinance loan at a higher interest rate than the original loan. It depends on how badly the owner needs the cash, for what purposes, and how highly levered their other assets are.

Commercial Mortgage Bridge Loans

An investor may also choose to take out a commercial mortgage bridge loan.

A commercial bridge loan is a short-term loan used to “bridge the gap” until long-term financing can be secured for the property. Most bridge loans have terms of two years or less.

They are often structured as interest-only loans with a hefty balloon payment at the end. Bridge loans tend to command higher premiums, averaging one to three percentage points higher than the average market rate.

Bridge loans are often used to renovate a property that otherwise won’t qualify for a traditional mortgage before selling it or getting long-term financing.

Commercial Refinance Lenders

People tend to think of traditional banking institutions as the one-stop-shop for refinancing commercial real estate, but there are several other types of lenders that also offer refinancing loans.

Here are a few options to consider if shopping around for a new loan.

Traditional Commercial Banking Institutions

The most straightforward way to refinance commercial real estate is to approach a traditional banking institution.

Wells Fargo, Bank of America, JPMorgan Chase, and KeyBank are just a few of the traditional commercial banking institutions that can assist with refinancing commercial property.

All commercial banks generally offer relatively similar loan terms, perhaps a few basis points in one direction or another. Sometimes they have unique loan programs available to long-time or repeat customers, so it is wise to start with a bank where you already do business, and then shop around with the competition.

Hard Money Lenders

Hard money lenders are a type of private lender that some investors turn to when they can’t refinance through a traditional bank.

There is an entire spectrum of hard money lenders that specialize in various loan sizes and risk portfolios. Hard money lenders tend to have less favorable rates and loan terms than more traditional banks, but they are useful for those who need cash in a pinch.

SBA Loans

If you are a small business owner who also owns the real estate the business operates out of, you may want to consider an SBA 504 loan.

The SBA’s 504 refinance loan can be tailored to a variety of needs, from business owners facing high-interest mortgages to those with upcoming balloon payments.

SBA Logo Commercial Refinance Loan

SBA 504 loans offer low fixed rates with 10 or 20-year terms and are fully amortized. A commercial bank will typically provide a first mortgage loan and the SBA, through a local community development corporation, will provide a second mortgage of up to 90% loan-to-value.

The borrower usually only needs to contribute 10% as a down payment, which may be covered by the existing equity in the property.

Community Banks

Community banks, which are simply a type of traditional banking institution, tend to focus on real estate located within a specific geography.

Given their hyper-local knowledge of the real estate market, some are willing to take an aggressive approach to investing in the local landscape.

Examples of community banks include East Boston Savings Bank in Boston, First Foundation Bank in Los Angeles, and Dime Community Bank in New York City.

CMBS Loans

Commercial mortgage backed securities (CMBS) loans, also referred to as “conduit loans,” are a type of commercial real estate loans that are packaged and sold by conduit lenders, commercial banks, investment banks or syndicates of banks.

Because CMBS loans have little to no cash-out restrictions, this type of refinancing is popular among investors looking to extract equity from their properties. CMBS loans typically have a 75% loan-to-value maximum.

For example, if a property worth $20 million has a remaining loan balance of $8 million and the owner wants to get a CMBS refinance with a 75% LTV, they could take out approximately $3 million from the property.

Crowdfunded Loans

A rather atypical way of refinancing commercial real estate, though one that has grown in popularity, is via several crowdfunding platforms that have sprung up in recent years.

Companies like CrowdStreet, Patch of Land, and RealCrowd help investors crowdsource funds to refinance their commercial real estate projects.

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