At its core, a commercial real estate refinance involves taking out a new loan to pay off an existing one. Investors often use refinancing as a method to secure better loan terms. With that in mind, here's a guide to the commercial refinancing process. You'll learn about when it makes sense to refinance (or look into loan defeasance), eligibility requirements you might face, and tips on how to find the best loan program for you.
Why would an investor consider a commercial real estate refinance?
Now that you have a better idea of what a commercial real estate refinance is, the next step is to take a look at the reasons why someone might want to refinance their commercial loan. Truthfully, there are many benefits to making this financial move, such as the following.
Avoiding balloon payments
Commercial loans mature much faster than residential mortgages. While these loans still amortize over a period of 25 years, most come due within only a few years of making small, incremental payments. While the average loan term on a residential mortgage is 30 years, on a commercial loan the loan term might only be two, five, or 10 years.
At the end of the loan term, a balloon payment for the remainder of the loan amount is usually required. As you might be able to guess, a balloon payment is a large lump-sum payment for the remainder of the loan.
However, property owners can avoid having to make this payment if they refinance the loan before the balloon payment comes due.
Taking cash out for improvements
Another reason why someone might decide to refinance their property is to leverage the equity they've built up in order to fund improvements. This is done using what's known as a cash-out refinance. As the name suggests, you can borrow more money than you owe on the property. In this case, the difference between what you've borrowed and what you owe is given to you as funds, which you can use however you see fit.
Many investors choose to use these funds to make improvements to the property. The thinking behind this is that when they're done making improvements, they'll be able to charge the tenants higher rent, increasing their profits.
Securing a better interest rate or loan terms
Lastly, some investors might choose to refinance in order to secure a better interest rate or more favorable loan terms. Though commercial financing is often subject to higher interest rates than residential loans, refinancing when rates are low can help you lower your monthly payment, which will increase your cash flow.
It's also possible to refinance in order to secure better loan terms. Many commercial loans have an adjustable interest rate. If rates are rising, an investor might choose to refinance into a fixed-rate loan option to provide greater stability. In addition, many commercial loans also come with a prepayment penalty, so an investor might want to refinance into a loan without this penalty.
What are the eligibility requirements for a CRE refinance?
Next, it's important to consider the eligibility requirements for refinancing a commercial real estate loan. The requirements are much different than what you might expect to see with a traditional mortgage.
Net operating income (NOI)
In the world of residential mortgage loans, the borrower's income and personal credit score are usually two of the biggest determining factors in whether they get approved. For commercial real estate owners, however, the biggest determining factor is usually the building's net operating income (NOI).
Net operating income is a measure of the income generated by the property, less its operating expenses. For the lender, a strong NOI proves the investor has enough income regularly coming in to sufficiently cover the loan payments. In general, the higher your NOI, the better the loan terms you'll receive.