Five steps for refinancing a commercial real estate loan

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October 20, 2017 | Updated October 23, 2017

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Key Points

Refinancing a commercial real estate loan

  • There are defined steps a borrower should take in advance of a refinance.
  • Refinancing can be used to consolidate debt, convert to a fixed rate or to cash out.
  • Loans with balloon payments generally need to be refinanced every five to seven years.
  • Market conditions can greatly influence a borrower’s ability to refinance under favorable terms.

In many ways, refinancing a commercial real estate loan is part of the game of owning commercial real estate. 

The process

Before you refinance, however, there are several steps you should take.

Step one: Evaluate your current loan terms. You should thoroughly familiarize yourself with the terms of the loan, its costs and interest rates. Without a good understanding of this basic step, you’ll not be able to evaluate whether it makes sense to refinance when you go shopping for a new loan.

Step two: Do you have a good reason to refinance? There can be several benefits to refinancing. It can be used as an opportunity to consolidate several debts and loans into one fixed payment. You may want to refinance to convert an adjustable-rate loan into a fixed-rate loan with more stable terms. Some people also refinance to draw equity, known as a cash-out refi.

Step three: Look at the costs. You may have good reasons to refinance, but refinancing also can be expensive. Origination fees could run in the tens of thousands. Many commercial loans are structured with stiff prepayment penalties. If saving money on your financing is your goal in refinancing, you must evaluate closely the costs of refinancing.

Step four: Watch out for balloon payments. One thing that makes a commercial loan a different animal than a residential loan is there often is a large balance left when the loan matures. That balance, which is known as a balloon payment, will need to be paid off in full, or refinanced. If your loan has a balloon-payment structure, it is a good idea to start looking at your refinancing options several months, or even a year, in advance. Loan refinances are standard in commercial real estate every seven to 10 years because many loans are structured with balloon payments.

Step five: Be prepared for some hard questions. Commercial underwriting is tough, and you have to come to the table prepared. You will need to gather up all the documents that tell the financial story of your business. In most cases, lenders with thoroughly review your cash flows, your credit and performance as a borrower, and market conditions.

Risks in refinancing

There are a few additional words to say about risks in a refinancing. Commercial loans tend to be much more complicated than home loans, and the underwriting is strict. The process can take several months or even a year.

If you have established a good relationship with a lender, however, you will usually have the opportunity to renew the loan under similar terms. Typically, the borrower will receive a renewal notice several months in advance of the loan term.

There are a number of factors that can complicate a commercial refinance, however. One big threat to a borrower is a change in market conditions. If the value of the underlying property falls, this often puts the property owner in a bind. During the last boom in asset prices a decade ago, for example, properties tended to be significantly overvalued. When the market crashed, the values plunged. Building owners were unable to refinance the full amount of the loans, and many ended up in default.

There is less risk of this today, but market downturns are always a risk. When markets turn down, lenders are also far less likely to make loans. In good times, lenders may be willing to provide a loan worth up to 80 percent or more the value of a property. In bad times, however, they may only provide financing at a level of half the value of the property. The borrowers, then, have to come up with the balance, often out of their own funds.

The bottom line is that refinancing a commercial real estate loan is usually part of the game in owning commercial property. It is a tough process, but by taking these few steps, the process can go a lot smoother. For a well-performing property, financing is almost always available.


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