How to select the fixed period for my commercial loan

Question

I’m closing on a sixplex, in Des Moines, IA, here in about a week. I don’t love the loan I’m getting, but it’s getting me started, and that’s what’s important right now. There’s a

“Range of balloon note products that we offer for multi-family. They range from 3yrs fixed to 20yrs fixed and are all amortized over 25yrs with a minimum of 20% down. Closing costs typically are around $1,600 plus .25% of origination. Below is a range of rates for each fixed period.

3yrs – 2.75-3.00%

5yrs – 3.10-3.35%

7yrs – 3.40-3.65%

10yrs – 3.65-3.90%

15yrs – 3.95-4.20%

20yrs – 4.20-4.45%”

Per my lender. Now once we get in to the property we’re planning to do a substantial renovation in each unit. Once the rehab is complete and the tenants are stabilized we want to do a cash out refi to get our money out and into the next deal.

So would it be better to take a shorter fixed period at a better rate? Since we’re going to refi at the end of the rehab, we’re not sure if it makes sense to be paying a higher rate during the rehab? Any advice is greatly appreciated.

Also, if anyone has a great commercial lender that would like to help w a refi when the time comes! Thanks!

Ken Naim · Answer

@Joseph Lyons if you plan on refinancing soon after the rehab a shorter term loan is the way to go. You want the loan term to be inline with your exit strategy. Most commercial loans have prepayment penalties and sometimes they can be substantial depending on how they are calculated and the current market rates.

Without a prepayment penalty I'd take a loan option that is the next one down the list from your plan. So if you think the rehab will take 18 months and are considering a 3yr loan, take the 5 year option. Life happens and things take longer than expected, rates fluctuate, bank become more conservative, so it is good to be covered for a little longer.

With prepayment penalties you have to do the math and make sure you can live with the penalty in various scenarios.

Joseph Lyons · Answer

Just revisiting this post after what feels like an eternity. I ended up going with a 3 year fixed rate period, as I knew I’d refi after reno. I finished the reno on all of the units in 5.5 months. Based on some of the feedback, it seems that that’s not common. But I’m in Des Moines, Iowa, not California, so the backlogs that we’re spoken of were non existent. There was one full gut, and the rest were heavy cosmetic (cabinets, floors, paint, fixtures etc).

Once the rehab was a month from completion I approached my lender about getting an appraisal for a cash out refi. He was on board. He set up an appraisal with the soonest available appraiser and the appraisal came back in excess of our expectations. We are now in infinite return territory, as our basis is now zero (rather its negative, since we came out with a profit). This all occurred about 7 months from the final purchase date. We left the first loan alone and did a second mortgage (10 year fixed, 25 year am) instead of a full refi so that we could keep the attractive rate that accompanied the loan in November 2021.

We now have an offer in on a 14 unit that is firmly within our abilities to take down. So much development in 7 short months. Sky’s the limit guys. Thanks for your help.

John Warren · Answer

@Joseph Lyons I'm not sure what it is you don't like about the loan terms you are being quoted. I am very active here in the Chicago market, and those rates are substantially below what I have been paying. I also have some pre pays baked in which I should probably push back on next time I have a refinance, etc.

My main concern in commercial RE is that the lender will actually close. I always buy value add deals which this one sounds like it is, and a lot of lenders will quote you these low rates/attractive terms only to pull back once it turns out you don't have a whole lot of financials going into the deal, etc. If you are buying a stabilized deal, then by all means focus in on the interest rate, long term, etc. You are essentially just looking for a bridge product here.

The other thing to think through is your exit loan. In my experience, commercial lenders HATE cash out refinances. This came as a nasty surprise to me when I did a BRRRR deal on a six unit in Cicero here in Chicago area. I literally hit all of the metrics you are supposed to hit and should have had no issue cashing out. What i found out though, is that commercial lenders want to see you season the property for about 2 years before you can get full cash out. I was stuck cashing out my hard money lender at 80% loan to cost (not loan to value) which means I left 20% of my money in the deal.

Caroline Gerardo · Answer

Nominal difference in rates- is there a prepay, what are the points at these rates? I would choose the 10 or 15 year if the costs are all the same. Try to pay no points or get rebate pricing as the appraisal for commercial is EXPENSIVE, and all the other costs you will pay a second time with a refinance at unknown rate in the future

John Warren · Answer

@Joseph Lyons you are correct that a fixed interest rate for the life of the term is very uncommon. I typically get 5 year terms with 25 year amortizations on most of my deals. You can find a 30/30, but it is not super common and you typically pay a higher interest rate. Here in Chicago Renovo will do these deals.

The tricky part here is that you often times get a more conservative lender if the terms are great. For me as a value add investor, I need the bank to be able to close with limited paperwork. Some of the lenders that offer amazing terms will back out of the really juicy deals since they aren't stable enough OR, they will ask for a larger down payment which is the other way they have of killing deals that they don't want to outright deny.

My last thought here is that almost no one I know actually holds loans and pays them off. That is why the shorter term may make sense.

Joseph Lyons · Answer

@Brandon Bohlender i sent you a private message with info for lender

Brandon Bohlender · Answer

Nice work. Mind sharing who you went with for lending? Always looking for more lending options.

Mike L. · Answer

@Joseph Lyons

If you are set on doing a cash out refi, I’d do the 3 year term. As the other guy mentioned, for a cash out, you’ll certainly be required to have held the property for 2 years.

If you don’t have to cash your money out, that 20 year term on a 25 year schedule is really attractive (if you can get this on a refi, do it). It’s attractive because towards the end of your 20 year schedule you’ll be paying your principal down much quicker at the beginning. You may even ask for a 20 year am schedule and 20 year term so it gets completely paid off.

Jonathan R McLaughlin · Answer

@Joseph Lyons the prepaid are common, can usually get in writing they won’t charge if you redo with them. They usually step down over the fixed rate period 3 or 5 years. (5% year one, 4% year two etc.

I would look at the difference between the 3 year rate and the 5 or 10 as an option payment or insurance premium….how much have you really lost if you want to change your strategy for any reason?

MYbe you want to hold a little longer you won’t be coming up on any deadlines. 3 years can go buy awfully quick :)

Don’t sweat the rate, those are good terms

Joseph Lyons · Answer

@John Warren when I said I didn’t love the terms, I meant that I didn’t love swinging from single family 30 or 15 year fixed interest rates to having 25 year am w/ balloon and variable fixed rate periods. As I understand though, balloons are common in CRE? Is getting a fixed interest rate for the life of a loan an option once you’ve established yourself? Obviously, that’s not what I’m trying to do at this time, but I want to be aware of what’s available. I realize I can buy a fixed rate for the life of the loan (more or less) by selecting the 20 year fixed period, but the interest rate is less attractive. Is that just table stakes in CRE?I explained plainly to my lender that I was planning to do substantial rehab work and a cash out. He said, “yeah, it may be wiser to do a 3yr if that will be your plan. Then you could do a new 10yr down the road for your refinance”. Everyone on this thread has been extremely helpful. Thank you all for your wisdom. I’ll have to do more research on prepayment penalties, as that topic has not come up between my lender and I.

How to select the fixed period for my commercial loan

How to select the fixed period for my commercial loan

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