How to Refinance a Commercial Property

Refinancing a commercial property involves replacing an existing mortgage with a new one, often to secure more favorable terms or to access equity. This strategy is common for optimizing real estate investments and requires careful consideration. Understanding available options and aligning them with financial goals helps owners make informed choices.

Understanding Commercial Refinancing Objectives and Options

Commercial property owners pursue refinancing for several strategic objectives. A primary goal is often to reduce interest rates, which lowers monthly payments and overall borrowing costs. Owners may also change loan terms, extending repayment to reduce monthly obligations or shortening it to pay off debt faster. Cashing out equity leverages appreciated value for improvements, acquisitions, or other business investments. Refinancing can also consolidate multiple debts into a single loan, simplifying management and potentially securing a lower blended interest rate. Owners with adjustable-rate mortgages may refinance to a fixed-rate loan for payment stability and protection against rising interest rates, especially before a balloon payment.

Conventional commercial loans are provided by traditional banks or credit unions. These loans offer flexibility in terms and conditions, typically requiring a loan-to-value (LTV) ratio of 60-85%, with terms from 3-15 years and amortizations up to 30 years. Conventional loans are full recourse, meaning the borrower is personally liable. Lenders require a strong credit history and substantial post-closing net worth and liquidity.

Small Business Administration (SBA) 504 loans are designed for purchasing or refinancing owner-occupied commercial real estate to promote business growth. This program involves a three-party structure: a conventional lender provides up to 50% of financing, a Certified Development Company (CDC) provides up to 40% (backed by an SBA guarantee), and the borrower contributes at least 10% equity. SBA 504 loans offer long-term, fixed rates and lower down payments, making them attractive for eligible small to medium-sized businesses acquiring or improving real estate, provided the business occupies at least 51% of the property.

Commercial Mortgage-Backed Securities (CMBS) loans are pooled with other commercial mortgages and sold as investment-grade bonds. These loans are non-recourse, limiting personal liability to the property itself, except for “bad boy” carve-outs related to fraud or misrepresentation. CMBS loans feature fixed interest rates, 5-10 year terms, and 25-30 year amortizations, usually with a balloon payment at maturity. Underwriting for CMBS loans focuses on the property’s income potential and value rather than the borrower’s personal credit.

Private or hard money loans are used for short-term financing or when conventional lending is not feasible due to time constraints or property conditions. These loans are provided by private investors or non-institutional lenders, and feature higher interest rates and shorter terms (6-36 months), with interest-only payments and a balloon payment. Hard money loans are asset-based, driven by the property’s value and equity, making them a quicker, though more expensive, solution for situations like property renovations before securing long-term financing.

Preparing Your Application Documents

A comprehensive collection of documents is necessary before applying for commercial property refinancing. Lenders require this information to assess the property’s value, income potential, and the borrower’s financial capacity and creditworthiness. Organizing these materials in advance can streamline the application process.

Property financial documents provide a clear picture of the asset’s performance. Detailed operating statements, including income and expenses (typically for the last two to three years and year-to-date), are essential. Lenders require rent rolls, detailing current tenants, their occupied space, and lease terms, along with copies of all existing lease agreements. Property tax statements and current insurance policies are necessary to understand operational costs and risk coverage.

Borrower financial information is important for lenders to evaluate repayment capability. Personal and business tax returns for the past two to three years are standard. Personal financial statements (outlining assets and liabilities) and business financial statements (including balance sheets and profit and loss statements) are crucial for assessing overall financial health. Recent bank statements for the last three months provide insight into cash flow and liquidity.

Beyond financial records, specific property information is required to verify its physical and legal standing. Lenders usually order a new appraisal during underwriting to determine the property’s current market value. A Phase I Environmental Site Assessment (ESA) helps identify potential environmental liabilities. A title insurance policy confirms clear ownership and protects against title defects, while a recent survey verifies property boundaries and identifies any encroachments or easements.

Legal and existing loan documents complete the application package. Copies of entity formation documents, like Articles of Incorporation or Operating Agreements, are needed to confirm the borrowing entity’s legal structure. All existing loan documents, including current mortgage statements detailing outstanding balances and any other property liens, must be provided to show the current debt structure the new loan will replace. Preparing these documents accurately and completely expedites the lender’s review.

Navigating the Application and Underwriting Process

Once documentation is prepared, the commercial property refinancing journey progresses to application submission and underwriting. Borrowers submit the package to their chosen lender for initial review. This preliminary assessment checks for basic eligibility and completeness of information.

Underwriting begins as a detailed evaluation where the lender reviews all submitted documents to assess loan risk. Underwriters analyze the borrower’s creditworthiness, financial stability, and ability to repay the loan, alongside the property’s value, income potential, and market conditions. This ensures the proposed financing aligns with the lender’s risk tolerance and regulatory requirements.

During this phase, the lender orders several third-party reports to verify information and assess risks. A new appraisal is commissioned to establish the property’s current market value, crucial for determining the maximum loan amount. An updated environmental assessment, such as a Phase I ESA, identifies potential environmental concerns. A title search confirms clear title, identifies encumbrances, and ensures the lender’s lien will be properly secured. These reports inform the lender’s decision-making process.

The underwriting team may request additional information or clarification on submitted documents. This communication is standard, as underwriters seek to understand all transaction aspects. Timely responses from the borrower prevent delays. Upon satisfactory review, the lender may issue a pre-approval or conditional approval, outlining proposed loan terms and any remaining conditions for final closing. This conditional approval signifies the lender is prepared to move forward, pending fulfillment of specified requirements.

Finalizing the Refinance Transaction

After application and underwriting are complete and the loan is approved, the refinancing process moves into its final stages. The lender issues a loan commitment letter, a formal document outlining the loan’s terms and conditions. This letter details the loan amount, interest rate, repayment schedule, collateral requirements, and covenants or conditions that must be satisfied prior to closing. Careful review of this commitment letter ensures all agreed-upon terms are accurately reflected.

The closing process involves multiple parties, including attorneys, title companies, and the borrower. The title company plays a central role, ensuring documents are prepared, signed, and recorded. Attorneys for both lender and borrower review legal documents to protect their clients’ interests. This stage includes signing new loan documents, such as the promissory note and mortgage or deed of trust, which legally obligate the borrower to the new terms and secure the lender’s interest.

During closing, the borrower reviews closing disclosures, detailing all financial aspects: loan amount, interest rate, monthly payments, and associated fees and costs. These costs typically range from 3-6% of the loan amount and include loan origination fees (0.5-1.0% of the loan), appraisal, environmental, and title insurance fees. Other expenses like legal and recording fees are also settled.

Upon successful signing of all documents and payment of closing costs, the new loan is funded, and proceeds pay off the existing commercial mortgage. The old loan is retired, and the new mortgage is recorded with county or state authorities, establishing the lender’s new lien. While closing marks the formal end of the transaction, some post-closing steps may be required, such as providing additional documentation or fulfilling agreements outlined in the loan commitment. These actions ensure all legal and administrative requirements are fully satisfied.