Commercial Cash Out Refinance vs. Selling
Looking to get some cash out of the investment you’ve been maintaining? You might think that your only option is to sell the property, which can be costly and means you’ll no longer enjoy the benefits your investment might have been bringing on an ongoing basis, or could bring in the future. So are you out of options?
Not necessarily. In commercial real estate, there’s a transaction known as a commercial cash-out refinance, and it’s a powerful way to access cash out of your commercial property mortgage without having to sell it outright.
While a commercial cash-out refinance does come with a unique set of complications and requirements, it can be the best move for a wide range of borrowers. The best part is that many capital providers are also familiar and comfortable with commercial cash-out refinance plans and can help guide you through the process.
In the meantime, let’s take a look at exactly what a commercial cash-out refinance is, reasons to use one, examples of what they look like, and what you’ll need to make it happen. We’ll also guide you through the advantages of a cash-out refinance and some of the reasons why they can be preferable to selling your property.
What is a commercial cash-out refinance?
A commercial cash-out refinance is much like a traditional refinancing plan you might expect, with a few key differences. In a commercial cash-out refinance, the new mortgage advance provided by your lender is greater than the amount of the existing mortgage and associated settlement costs.
In this setup, the original mortgage is gone and replaced with an entirely new one. The difference in funds between the original loan and the new one are made available to the owner of the property in what’s known as a “cash out.”
Obviously the amount of money available to cash out depends on several factors, the greatest of which is the loan to value and debt ratios as well as the appreciation of the property over time. These commercial cash-out refinances are available to trusts, partnerships, corporations, LLCs, estates, and even foreign nationals.
Certain lenders place no limitations at all on what you use the funds you receive for your cash out. That’s as opposed to many banks which will impose extremely strict restrictions on what you can and can’t use your freed money to purchase, if they even offer cash-out refinancing at all. This is important to note, as you don’t want to initiate the commercial cash-out refinance process with a lender only to find out that you won’t be able to use your cash the way you want to use it.
Advantages of Commercial Cash-Out Refinance
Now that we’ve delved into the details of cash-out refinancing, what are some of the biggest advantages? While this can differ from situation to situation and borrower to borrower, there are three main benefits of a commercial cash-out that can be a major game changer when it comes to your cash flow and the long-term success of your commercial property investment.
1. Cash Proceeds Aren’t Taxed
One of the best benefits of a commercial cash-out refinance? The cash you receive as a result isn’t considered taxable income. This is a huge benefit, particularly considering that selling the property would result in proceeds of the sale being taxed. That makes a commercial cash-out refinan
ce a great way to access cash flow without giving a large portion of it away.
2. Rates Are At Historic Lows
There’s hardly ever been a better time to refinance, with interest rates at historic lows—offering you the chance to not only enjoy more cash out, but to restructure your cash-out loan so that it’s more beneficial to you in the long run. Don’t forget that besides the access to instant cash flow, a cash-out refinance also carries all of the benefits of a traditional refinance in terms of making the loan more beneficial based on your current circumstances and the excellent status of the market.
3. You Keep the Income of the Property
Don’t forget one of the best benefits of a cash-out refinance—you keep the income that the property will continue to generate. As opposed to selling a property, a cash-out refi allows you to have it both ways. You can access an instant cash infusion while also continuing to enjoy the income of the property. It’s the best of both worlds.
Disadvantages of Selling
For every benefit of a commercial cash-out refinance, there’s an associated disadvantage of selling rather than refinancing. Here are the three primary reasons to avoid selling your property when possible.
1. Taxed on Proceeds of Sale (Non-1031 Exchange)
That’s right—proceeds resulting from the sale of your property in a non-1031 exchange can be taxed by the government. That means that some of the value of your sale will be stripped away, as opposed to a cash-out refinance where all cash proceeds resulting from the transaction are completely tax-free. This is especially important for long term holder that have depreciated their assets and seen property values increase substantially.
2. 1031 Exchanges Require Buying When Values Are High
In order to avoid some of those heavy taxes, you can try to go for a 1031 exchange. The problem? Real estate prices are very high and often an investor can end up in a worse position by having to purchase a property that is overpriced due to the short window to use the 1031.
3. No More Income from Property
Finally, the biggest downside of selling your property is that the moment it’s out of your hands, it no longer serves as an income stream. You might get a chunk of cash from the sale, but the figure is finite. A profitable property can continue bringing in income for years or even decades.
Reasons to Complete a Cash-Out Refinance
Why initiate a cash-out refinance for your commercial property? There are multiple potential reasons.
First, you might be looking to consolidate debt—similar to when home owners refinance their homes. You can use cash from your refinance to pay business debts and other outstanding balances owed in order to take some stress off your monthly balance sheet.
You can also transfer the equity in your business into investments that will return you higher yields. For example, you might want to invest your money into an area that will give you a higher rate of interest return than the interest rate of your business loan.
Another common use for cash-out refinancing funds is making improvements to your location through remodeling or refurbishment. This is a powerful way of pulling cash out of your property only to invest it in areas that will increase its value to the maximum possible level.
Finally, a cash-out refinance might be necessary to avoid foreclosure. It’s certainly preferred to having the bank foreclose on a commercial property that you can no longer afford.
These are just some of the reasons and applications for a commercial cash-out refinance. Now let’s look at an example of one in action.
Example of a Commercial Cash-Out Refinance
Let’s say that you’re a borrower with a $5 million business loan on an investment vacation property in Vermont. You purchased the property roughly a decade ago, and since then you’ve both paid down the loan and seen the value of the property increase.
So you contact a lender who handles commercial cash-out refinances. They arrange a cash-out mortgage that’s roughly 75% of the newly appraised value of the property. This results in an upgraded loan of $8 million, which would result in nearly $2 million in cash being paid directly to you as the o
wner. This new loan might be structured as a non-recourse, 10-year fixed loan with competitive rates and an amortization period of 30 years.
While this is not an exhaustive example, and there are many other circumstances where a cash-out refinance would be hugely beneficial, it speaks to the power of a commercial cash-out refinance for borrowers and investors of all kinds.
Common Requirements for Cash-Out Refinance
Generally, for a cash-out refinance there are a few qualifications that your lender will check for when applying. First, they’re likely to check your business credit, and sometimes that check will extend to your personal credit as well—particularly if you are personally guaranteeing the refinanced loan.
Your lender will also look at the available collateral through the property, plus other business figures like the property’s NOI, or net operating income. The NOI is actually one of the primary factors, because it’s used to assess the profitability and value of the property which will affect everything from the total loan amount to the amount of cash you’re able to receive in the structure of the commercial cash-out refinance.
Most lenders require a minimum length of ownership to consider a commercial cash-out refinance, with some as low as 12 months and others as high as several years. Many lenders also tend to prefer properties that are occupied by the owners, seeing them as more personally invested in the success of the property. That said, this is generally not going to be the deciding factor in a refinanced loan decision.
A commercial cash-out refinance isn’t the right call for every situation, but it might be the best way for you to continue enjoying income from your investment while quickly accessing cash flow as well as more beneficial terms on your loan.
Want to learn more? Contact Clopton Capital commercial mortgage brokers today to find out of a commercial cash-out refinance is right for you.