If you have a bridge loan that is coming due or is looking to lower your payments on a commercial loan, you might be faced with the decision of whether you should sell your investment property, or refinance.
There are several reasons why investors consider refinancing a property.
For one, refinancing allows investors to save money by taking advantage of lower interest rates. As long as the fees associated with refinancing don’t eat up your savings, refinancing could allow you to extend the terms of your mortgage, thereby lowering your monthly mortgage payment. This not only helps you increase your immediate cash flow, but it also increases the value of the property.
Other investors find themselves faced with refinancing due to a balloon payment coming due. Balloon payments are short-term loans that come due within 3 – 5 years and are often used for the initial purchase of the property.
Since payments often cover only the interest or a small portion of the principal, many investors often find themselves facing a hefty debt. This problem is only compounded if property values have dropped, or the property suffers from high vacancy rates.
Investors are then faced with the choice of selling the property – although there may be no guarantee of recouping their loss- or refinancing.
To decide what to do you’ll need to take several factors into consideration, but the ultimate question you need to ask yourself is which method offers you the greatest chance of maximizing your overall returns. To answer that question, you’ll first need to consider several important factors.
Have You Created Most Of All Of The Value There Is To Create?
If you haven’t already tried value-add strategies, now is the time to consider whether or not you can utilize this method to increase the value of the property. If you decide to sell the income property, then this will increase your profits. If you plan on refinancing, this will increase the amount of equity available in the property and make the loan more desirable to lenders.
There are five different ways investors typically add value to a commercial property.
Renovate
Renovating a commercial property in order to increase its value can range from a large-scale overhaul to simple cosmetic improvements. This works particularly well for multifamily properties, where something as simple as new paint, new flooring, and new landscaping can add significant value to a struggling property.
Other types of commercial properties typically require a more substantial rehab, such as renovating the lobby of an office building or modernizing the exterior of a retail property.
Increase rent
Increasing rent might seem like an obvious choice, but it’s one some investors hesitate to exercise for fear of turning off tenants. The truth is that as long as you can justify the increase – either due to renovations or because rents haven’t kept up with market prices, then increasing the rent is not only acceptable in terms of the law but ethically as well.
Decrease Expenses
Decreasing the expenses of operating the property might take some detective work, but if you’re persistent and thorough, you might find several areas where you can cut down. One of the first places to look is at how much you spend on electricity each month.
Although you can certainly attempt to find vendors that cost you less, you’re more likely to lower expenses by using energy efficient light bulbs, installing individual gas or water meters for multifamily units, and by switching to faucets and toilets that use less water.
Add tenant amenities
Adding tenant amenities isn’t an inexpensive proposition, particularly if you’re talking about commercial properties like offices or high-end multifamilies.
Hot office amenities include accessible food options (Pret A Manger, Brown Bag, Cosi or Fridays are good examples), a fitness center, shared conference space, or fast reliable wifi. Multifamily tenants prefer fitness centers, conference rooms, outdoor living spaces, and pet-friendly buildings.
Change the Property’s Intended Usage
Changing the property’s usage from one type of property to another can often increase the value of the property. This has long been done in cities transforming to hot spots, as industrial properties are converted to apartments or office and retail buildings are converted to mixed-use properties.
What Does The Market Look Like?
Analyzing the market in your area will help you determine whether or not commercial property values are likely to up or decrease. Keep in mind that the market will look very different depending on your real estate goals, the niche you specialize in, and your location.
When analyzing the market, one of the first things you’ll need to do is determine what stage the market is in. There are four stages: recovery, expansion, hypersupply, and recession. Factors like vacancy rate, gross asking rate, and supply and demand numbers are some of the things you can use to help you predict where the market is at but don’t discount a thorough walk and talk in the neighborhood where your property is located.
If you live in the same city as the property, try taking a walk around the neighborhood where it’s located. Hopefully, you make this a regular occurrence, so you can spot changes going on that might affect your property’s value. Have you noticed more businesses closing? Or have you seen an influx of new businesses or new age groups (millennials or retirees, for example) that hint towards a growth spurt?
When walking around the area, do you notice a lot of for rent (MF) or for lease (retail and office) signs? Flip through the local paper. Are there a lot of vacancies in the area? Are there certain areas that never seem to have any vacancies?
After you’ve gotten a good impression of the neighborhood by walking and talking to people who know the area the well, it’s time to check the stats.
Compare crime rates and school ratings over time to see if an area is holding it’s own in terms of value. New business developments planned by the city or county hint towards expected growth in the area. All of these factors can give you a good picture of what the market is like for your specific property type in your particular location.
Next, Run The Numbers
Your last step is to run the numbers based on the information you’ve gathered in the previous steps.
The simplest yet most accurate way to compare choices is to use the IRR, internal rate of return. Because the IRR takes into account the passing of time, it will allow you to compare options like selling your property now vs in five years from now, or refinance and sell later.
Once you’ve created a detailed financial model that calculates the various options (using an online calculator is probably the simplest way to do this if you don’t feel comfortable with spreadsheets), making sure you include all the cash flows from the investment, as well as profits or equity you might gain from a sale or refinance.
After everything is said and done, deciding whether to refinance or sell isn’t an easy decision.
For some, the fear of waiting too late to sell a property – particularly in today’s economy – might be enough to push them over the edge. Others are more sanguine about the matter, figuring that as quickly as the market can turn, holding onto the property long enough would eventually allow them to take advantage of the cyclic nature of the real estate market.
