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Tim Kelly is an expert in finance having completed her LLM in Finance (Master o

We are often are asked when is the optimal time to refinance a commercial real estate loan. Many factors such as market interest rates, prepayment penalties, existing loan terms and the overall goals of the borrower come into play. There are however no set answers, but below are some real world thoughts on how you might analyze your own commercial refinance.

Traditionally, the analysis to keep an existing loan in place or to refinance into a new commercial loan 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 loan will:

1. Affect their monthly cash flow.

2. What the closing costs will be and how these costs will affect their equity.

3. What the out of pockets costs will be.

4. How long will it take for the increase in cash flow to “pay back” the owner.

Principal pay down is obviously another important component of any commercial loan. However, for most owners, especially those with highly leveraged properties, cash flow is more pressing than above. This is due to the relative high debt payment versus net cash after all the expenses have been paid.

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 commercial loan. The borrowers primary motivation is a desire to increase cash flow to help businesses overall profitability. In addition the borrower has concerns over future rate increases when the existing loan balloons

Existing Loan – 5 year fixed 20 year amortization.

Property Value $1,500,000

Current Loan Balance $1,075,000

Original Loan Balance $1,125,000 (Purchased building with 25% down)

Current Loan to Value 72%

Current Equity 28% or $420,000

Interest Rate 7.25%

Monthly Payment $10,418

Proposed Loan – 30 year fixed, 30 year amortization. Borrower is planning on rolling as much of the closing costs as possible into the loan amount to reduce “out of pocket” cash.

Property Value $1,500,000

Current Loan Balance $1,075,000

Closing Costs $19,638

Proposed Loan Amount $1,094,638

Proposed Loan to Value 73%

Interest Rate 8%

Monthly Payment $8,582

* Closing Cost Break Down (Title at $2000, Lender Legal Fees $2000, Origination Fee at 1% or $10,838, Appraisal $3,000, Environmental $1,800).

Increase in cash flow is $1,835 per month or $22,028 annual. Essentially, from a cash flow perspective, the borrower would recoup the costs of 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” for these costs at close if desired.

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