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Commercial Loan RefinanceWhen is the optimal time to perform a commercial loan refinance? Many factors such as market interest rates, prepayment penalties, existing loan terms and the overall goals of the borrower come into play. There are no set answers, but below are some real world thoughts on how you might analyze your own commercial loan refinance. Traditionally, the analysis to keep an existing loan in place or conduct a commercial loan refinance can become very complex. Financial advisors like to use the Discounted Cash Flow method which essentially compares the two loans on the Net Present Value basis. We have found though, that most commercial building owners are primarily interested in how the proposed refinance will:
Principal pay down is obviously another important component. However, for most owners, especially those with highly leveraged properties, cash flow is more pressing. Example 1. Owner Occupied Office Building Borrower is 3 years into a 5 year fixed, 20 year amortized loan and is considering refinancing into a 30 year fixed, 30 year amortization loan. The borrowers primary motivation is a desire to increase cash flow(monthly savings to help businesses overall profitability). In addition, the borrower is concerned over future rate increases when the existing loan balloons in 2 years.
* (Closing cost break down - Title at $2000, Lender Legal Fees at $2000, Origination Fee at 1% or $10,838, Appraisal at $3,000, Environmental Report at $1,800). The borrower is planning on rolling as much of the closing costs as possible into the loan amount to reduce “out of pocket” cash. Increase in cash flow is $1,835 (savings) per month or $22,028 annual. Essentially, from a cash flow perspective, the borrower would recoup the costs of the loan in less than one year, despite the rate increase by 75 basis points. Although the borrower would have to pay for the appraisal and environmental report upfront, they would be “refunded” and rolled into the loan amount if desired. In our experience most business owners would be very interested in pursuing this transaction. Example 2. Investment Property, 10 Unit Retail Center Borrower has owned the property for 7 years and has two loans on the subject property. First loan is a conventional floating rate loan that adjusts annually, amortized over 25 years and the second is seller held. It is amortized over 20 years and has a fixed 20 year rate. Neither loan has a balloon provision; however the first loan does have a prepayment penalty of 5% of the remaining loan balance, which is in effect for 3 more years.
*Closing Cost Break Down (Pre Pay $72,500 [5% of 1st Loan amount], Title at $3000, Lender Legal Fees $2,200, Origination Fee at 1% or $17,185, Appraisal at $4,000, Environmental Report at $1,800). The borrower is planning on combining the two loans together, would like to roll as much of the costs into the loan, and wants the security of having a fixed rate loan. Cash flow increase(savings) is $2,704 per month or $32,449 per year while the cost to close the loan is high at $83,500, due primarily to the prepayment penalty. The borrower is facing a closing cost payback period of over two and a half years. In addition, the interest rate has gone up considerably on the proposed loan, which of course increases the overall long term cost of the loan. Not an easy decision for the borrower. The option to go forward would probably rest heavily on the borrower’s opinion of where the future interest rates will be when the prepayment period ends. It is interesting to note that the borrower would be able to increase his loan amount to $2,333,964 (cash out proceeds would be approximately $598,000) if he choose to. This is due to the increase in cash flow. The building Debt Coverage Ratio is at a 1.54 on the proposed loan; the typical minimum Debt Coverage Ratio is 1.2. If the borrowers intent was to pull cash out of the property to inject into another property (or for any other reason) this would probably be a much easier decision to go forward with the commercial refinance. Get real answers now, take a few moments to fill out the Pre Approval form for your commercial loan refinance. 248 885-8797.
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