When should you refinance commercial real estate? Do you wait until interest rates drop or can you do it when they're high? Is timing your commercial real estate refinances based on rates alone possible, practical or even smart? In this video, you'll discover when to strategically and intelligently refinance your commercial property for maximum wealth creation.
When to Refinance Commercial Real Estate?
Most residential investors refinance when interest rates are low. However, in commercial real estate that isn't always practical or possible. There are three differences that make commercial real estate unique:
- Most commercial loans are not fixed for 30 years like they are with residential real estate. In commercial real estate loans balloon in 5, 7, or 10 years. Regardless of interest rates, you will need to refinance in 5, 7, or 10 years or sell the property to pay off the lender.
- With our business model your biggest pay days will come from cash out refinances. The strategy is to buy commercial real estate, increase the rents and force the appreciation, putting you in a position to do a cash-out refinance and purchase another property. The question is, with high interest rates, do you wait? If you're sitting on a million dollars in equity, do you wait for interest rates to come down before pulling that money out?
- The fastest way to create walk away money (money to walk away from your job), is from strategic and smart refinances of your commercial property, whether interest rates are low or high.
How do you create walk away money? In our Protégé Program we teach our students to create walk away money with our business model. I've been using this commercial real estate investing strategy for over 20 years; however, it requires experience, and you need to be strategic when implementing it.
Refinance Business Model
- Buy well
- Stabilize the property
- Increase the rents to force the appreciation
- Season the net operating income (NOI)
- Do a cash out refi, pull out the equity
- Repeat Cycle
Here's how the cycle works. If you want to stabilize a commercial property, first you need to know how to buy well. After you stabilize the property, you can increase the rents. But how can you increase the rents if the property is not stabilized? You can already see why you need to be experienced or working with a coach or mentor.
Next, you will season the NOI. What I mean is you need to show the lender that your higher NOI, your force appreciation is stable over a long period of time. That takes skill. And then the final step is to do a cash out refi, pull the money out and reinvest in another commercial property. Again, you can't cash out refi unless you know how to season the NOI. The beauty of this business model is that if you refinance your commercial real estate and repeat this cycle three times, you can create the kind of wealth that enables you to walk away from your job.
The 3 Pillars of Refinancing
The question on everyone’s mind is, with the interest rates this high, should we even consider doing a cash out refi? And the answer is YES if you use the 3 pillars, taught to me by my dad, Sergeant Harris, you can refinance whether interest rates are high or low. These pillars are foundational when strategically refinancing your commercial property. If you want to be successful you need to practice these 3 principles:
- Have a Strategy
- Be Disciplined
- Be Patience
Refinance Commercial Real Estate: Business Model Example
Let's put this business model to the test. I'm going to go step by step through three cycles so you can see how you can create wealth by refinancing your commercial estate.
Buy Well: The first property is purchased for $600,000. I need to put 25% down, so my loan is $450,000 at a 4% interest rate. The monthly payment is $2,148/month. This property will cash flow at $1,500 a month.
Stabilize the Property/Force the Appreciation/Season the NOI: Over the next one or two years, I will stabilize the property and raise the rents. During this value-add period, the cash flow will increase from $1,500 to $6,200 a month. It took me money and time and skill to get to that level. With more cash flow and an increased NOI, now the property has a higher value of $1 million.
Cash Out Refi: I'm going to refinance and pull out the equity. I bought the property for $600,000 and now it's worth a $1 million. Lenders will allow a 75% cash out refi, which means they'll give you a loan for 75% of the new value. 75% of a 1 million is $750,000.
So, my new loan is $750,00 and I'm paying a higher interest rate of 7%. Now the monthly payments jump from $2,148 to $4,990 per month. Will the property cash flow? Of course, because I stabilized the property and increased the rents. However, the cash flow drops from $6,200 to $2,700 because I have a higher mortgage now.
Here's how the math on this cash out refi works:
- The property value is $1 million
- My new loan is for $750,000
- I use my new loan to pay off the original loan of $450, 000
- The remainder is $300,000
Now I will rollover that tax free $300,000 into another property. And remember, you can sit on it until you find the next great deal. So, take your time and be disciplined and patient.
Buy Well: I’m going to roll my $300,000 into a million dollar property. I'm putting down 25% and getting a loan for $750,000, paying the high interest rate of 7%. The monthly payment is $4,990. Cash flow is $2,500.
Stabilize the Property/ Force the Appreciation/Season the NOI: I'm going to renovate the kitchens, flooring, and paint, and get the rents up. This value-add period will take me one or two years, during which time my cash flow will go from $2,500 to $6,500. With more cash flow and a higher NOI, the value has increased to $1.5 million.
Cash Out Refi: I will apply the same strategy and do another cash out refi, borrowing 75% of the $1.5 million at a rate of 7%, which is $1,125,000 . My mortgage payment was $4,490 but now it is $7,485. That means my cash flow drops from $6,500 to $4,505.
Here's the math on this cash out refi:
- The property value is $1.5 million
- My new loan is for $1,125,000
- I use my new loan to pay off the original loan of $750, 000
- The remainder is $375,000
Again, I pull out $375,000 tax free and roll it over into a third property.
Buy Well: The purchase price of the third property is $1.5 million, again with 25% down. This time my loan amount is $1,125,000 with a 7% interest rate. My monthly payment is $7,485, and the cash flow is $4,000.
Stabilize the Property/Force the Appreciation/Season the NOI: I apply the same value-add strategy to this property to get the rents up, increase the NOI and force the appreciation. During this period, my cash flow increases from $4,000 to $10,000/month. Again, it can take several years. Remember, discipline and patience. Now, the property is worth $2.75 million.
Cash Out Refi: I will do another cash out refi, borrowing 75% of the $2.75 million, which is $2,062,500. Again, at the high interest rate of 7%. My mortgage payment was $7,485 but now it is $13,722. That means my cash flow drops from $10,000 to $3,763.
Here's the math on this cash out refi:
- The property value is $2.75 million
- My new loan is for $2,062,500
- I use my new loan to pay off the original loan of $1,125,000
- The amount leftover from my cash out refi is $937,000
What was the result of my strategy, discipline, and patience? After three cycles, I have three commercial properties in my portfolio, cash flowing a total of $10,000/month. And I have $937,000 tax free cash in my pocket. Guess what time it is? It's time to walk away from your job.
Why Not Wait for Lower Interest Rates?
Well, here's what you will miss out on while you wait:
- Cash flow
- Tax free Cash
- Tax Benefits
- Cost Segregations
- Creating a Track Record
- Creating a Financial Legacy
To gain greater understanding of Cost Segregation, a powerful tax saving tool, watch my video Cost Segregation Made Simple.
Creating a track record is important because you may want to transition into syndicating deals or leverage the $900,000 you have in your pocket to do much larger deals with other people's money. Check out my video the Basics of Real Estate Syndication and the amazing real world deal of one of our Protégé students to learn how to structure your deals with syndication: 0 to 314 Units in One Year!