Many successful investors use refinancing in order to keep their money from sitting in a property, preventing them from using a large amount of money or equity.
Refinancing commercial investment properties can allow you to pull out cash tax-free from a property for renovations, or to buy another property. It can also increase your cash flow and your cash on cash returns.
What Is Commercial Refinancing?
While home loans mature around 30 years, commercial loans mature at just five to ten years, which means the largest chunk of the loan comes due and will need to be paid off or refinanced.
The Net Operating Income is what will determine whether or not you’ll be able to refinance the commercial property. The higher and more stable the NOI is, the higher the property value, and the easier it will be to refinance the property or pull cash out. If the NOI has gone down or is too low, lenders will view your property unfavorably and will be much less likely to lend money for what they view as a risky property.
How Cash-Out Refinancing Works
While a home equity loan lets a homeowner access the equity of a loan and is a loan on top of your regular mortgage, a cash-out loan replaces the commercial mortgage.
Banks generally give not more than 75% LTV, which means for some investors, it’s a low-cost way to borrow money and get better interest rates and terms.
Plus you can increase your cash flow by lowering your monthly payments. Some investors use the extra cash to pay off existing bills, renovate properties they already own or purchase new properties. In addition, all the interest that has accrued is tax deductible.
The cons of a cash-out refinance include higher fees and closing costs that may add up to more than what you get in terms of the cash you receive. You should also consider that it will now take you longer to pay off your loan. If property prices drop before you end up paying off your loan, you may have trouble when it comes time to sell the property.
The terms and interest rates are especially important to pay attention to since the combination of the two can dig you unwittingly into a deep hole that will be difficult to climb out of without an additional refinance or sell the property at a loss.
Once you’ve examined the terms and interest rates and decided a cash out re-fi is for you, you’ll need to present two years of business tax returns, profit and loss statements, and other documents that will help lenders get a picture of the financial state of your property.
Some banks might also ask for a personal guarantee on the loan if they feel they won’t profit very much on the loan.
You will also have to get an appraisal, which you’ll have to pay for. Wait for the appraisal to come in before you start counting your chickens; appraisals can be tricky, especially if they come in too low or seem totally off-base.
Many banks are bringing in appraisers from out-of-state, which means they won’t necessarily know the area well. This can lead to an appraisal value you don’t agree with – which can be fought – but can result in a delay in getting your cash-out.
Be aware that lenders look at three factors when deciding whether or not to agree to a refi:
– Debt to loan ratio, which shouldn’t be more than 75%
– Debt ratio, which compares your monthly payment to the amount you earn per month in income. This determines your ability to repay the loan
– Debt service coverage ratio, which takes your yearly NOI and divides it by the number of loan payments per year. Generally, this number should not be higher than 125
Once you do get a cash-out, however, you can put a down payment on another property. If you take that property and add value to it, you increase your net worth and make it even easier to reach your investment goals.
Interested in selling or purchasing a commercial real estate property?
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