What's so important about refinancing commercial real estate? I have three compelling reasons.
- 1. It can immensely increase your cash flow and your cash-on-cash return, your ROI, on your investments.
- You can pull out cash from the property that's tax-free to either buy another property, to do necessary repairs or to do renovations and increase the rents. In my opinion, win, win, win.
- It's what most successful investors do to keep their money moving.
What is Refinancing Commercial Real Estate Refinance
(and how does it differ from a home loan refi?)
Most of you are familiar with refinancing a home. As your equity in your home goes up, you can refi into a better loan with better rates or even pull out cash. Most home loans mature in 30 years and are amortized over 30 years. Commercial loans, however, may amortize over 30 years but they also mature. They mature in five to ten years, which means, you can sell the property or refinance it into a new loan all together.
The other major difference is that commercial refinances depend on the NOI, the net operating income of the property but home loans do not. Therefore, the higher the NOI you can create, the better loan terms you can get, the more cash you can pull out and vice versa. If your NOI is lacking or unstable, your commercial refi loan may be denied.
Three Real Life Examples
1. Dave's Story
Dave and his wife own a 56 unit apartment building in Florida. They bought it distressed four years ago from a bank for a very good price, and two investors supplied the down payment. They would need to put money and work into the property, but Dave was not a very good property operator. He was not a good manager, which caused the property to suffer. The complex did not have a great reputation in the community and the rent collections were very poor, which meant the investors were not getting paid.
So Dave came to me for advice and actually wanted to sell the property and quit real estate all together. But, I saw potential, not only in the property, but in Dave and his wife if we could get the property to run properly.
Over the course of 18 months we repositioned the property with better tenants and improved looks on the inside and out. We painted the building, cleaned up the landscaping to approve the curb appeal, redid the kitchens, bathrooms, and installed new flooring. Rent collections are now consistently over 95% and the rents have gone up over 25%.
To Sell or to Hold?
It was now time to make a decision on whether they should sell or hold onto the property. As their coach and mentor, I advised them to refinance now because the NOI has gone up significantly and is now stabilized. As everyone knows, as your NOI goes up, your property value goes up. I then recommended that they pull out the cash to pay back their investors, which would make them happy. Then I suggested that they keep the property and reinvest their money and investor's money into another property to keep the commercial real estate investing journey going.
The end result was a happy wife, pleased investors who had now spread the word and helped him raise more capital for his next property, and renewed confidence to do this business full-time. They are now full-time real estate syndicators.
The lesson is to get help if you have a property with potential. Make sure you realize the potential and work your butt off to meet that potential. Then refi because cash pleases everyone.
2. Daryl's Story
Daryl has worked in sales for the last 28 years. He's really good at it but works long hours and is pretty much 100% commission. It is stressful and exhausting work.
12 years ago, Darryl purchased a 14-unit property in New York City as a retirement investment. Once, he began to tell me more about the property I realized he could possibly retire sooner or work a lot less hours sooner with a smart refi. His original loan balance when he bought the property was 1.6 million at 6% interest and it was amortized over 20 years. His payments were about $11,000 a month and he had been paying down his mortgage for 12 years, making his mortgage balance now around $800,000. He had a ton of equity in the building and a really small loan balance compared to the profits he was making.
Daryl's Two Choices
- He could continue to pay the $11,000 per month for another eight years, and then his property would be completely paid for.
- He could refinance at his current loan balance of $800,000, with a lower interest rate and longer amortization schedule which would increase his cash flow and reduce his payments. $800,000 at 5% interest amortized over 30 years, would drop his mortgage payments to about $4,000 per month, for an increase in cash flow of about $7,000 a month or $84,000 a year.
3. Alan and Myra's Story
Alan and Myra's situation own a small shopping center, midtown, in an excellent location. They love the property and it has been in the family for years with decent cash flow. The issue is their loan matures next year, which means they're going to have to get a new loan at that time. When you refinance a home, the lender will value your refi based upon the comparable sales in the neighborhood. They'll find a comparable commercial property and the lender will put a huge emphasis on the NOI, the net operating income, to be at a certain level and stable for a certain period of time.
Alan had not been the best landlord lately and has about 3,000 square feet of space that's been vacant for two years, not because of the demand in the area, but because he hasn't done anything with it. His second problem is that he lets a few of the tenants not pay their full rent because he's friendly with them. I warned Alan that it's likely that his lender for his refi will not approve the refi at the loan he wants, because of these issues.
When Alan applied for a new loan with a local lender they said they would do the loan, but the interest rates were way too high and the other terms were horrible. They wanted him to put money in the escrow and the amortization schedule was way too low. I explained to him that they gave him terms as if the property was high-risk and distressed, because to lenders, t poor rent collections and too high vacancy, mean high risk. Alan and his wife didn't see their property as distressed but the lenders did.
In the end, they were able to refinance their commercial real estate property with good terms once they paid closer attention to the needs of the property. Alan got the 3,000 square feet leased out and they started requiring all of their tenants to pay on time.
- Always run a tight ship because every property with a loan on it has a refi right around the corner.
- Keep your eye on the NOI.
- You can use refinancing commercial real estate as a tool for, repositioning your investing journey of the property. If you improve the property's financials and performance, it will enable you to pull out cash, repay yourself, repay investors, buy another property, or do whatever you want. The journey will not only continue, it can take you to greater heights. Look at a refi as a repositioning tool for, not only the property, but for yourself.
2. Look at refis as a way to increase cash flow. What's the biggest indicator that you're ready to work less hours or leave a job? It's not net worth or equity in the property; it's cash flow. Here's a quote from Jim Rohn, "Your income needs to exceed your outgo. That's when you know you're ready."
3. Keep an eye on when your loan comes due. Paste it on a board some place and make sure your property's financials are stable and strong. Don't let the property's condition, occupancy, or NOI fall apart or else you may not qualify for a refi. Keep the property's curb appeal looking nice, maintain at least 90% occupancy, and maximize your NOI continually.