Refinancing Commercial Real Estate, Explained Simply

Refinancing commercial real estate means replacing a property’s existing loan with a new one. Owners do it to get better terms, to replace a loan that’s coming due, or to pull out cash the building has built up, which is called a cash-out refinance. The new loan’s size is usually limited by two tests: loan-to-value (LTV) and the debt service coverage ratio (DSCR).

This guide explains both tests, walks through a cash-out refi with round illustrative numbers, and covers the risks. Then we’ll show how refinancing works as a move in CRE Tycoon, where it’s one of the fastest ways to grow a portfolio.

Why owners refinance commercial property

There are three common reasons:

1. Rate and term. The owner replaces a loan with one that has a lower rate, a longer term or friendlier terms, without taking cash out.
2. Maturity. Many commercial loans come due before they’re fully paid off, leaving a large remaining balance (a balloon). The owner refinances to pay it.
3. Cash out. The building is worth more than it was, or the loan has been paid down, so the owner borrows more against it and takes the difference as cash.

The third reason is the one investors talk about most, because it lets you reuse your money without selling.

The two tests: LTV and DSCR

Loan-to-value (LTV)

LTV = Loan amount ÷ Property value

The value comes from a lender-ordered appraisal. If a building appraises at $1,000,000 and the lender’s maximum is 70% LTV, the most you could borrow on that test is $700,000.

LTV protects the lender. If things go wrong and the property has to be sold, there’s a cushion between the loan and the value.

Debt service coverage ratio (DSCR)

DSCR = Net operating income ÷ Annual debt service

Debt service is the total of a year’s loan payments, principal and interest. A DSCR of 1.25 means the building’s NOI is 25% more than its loan payments. Each lender sets its own minimum.

DSCR protects the lender from a different risk: that the building can’t pay the loan from its own income. Since NOI is the starting point, it helps to know exactly what goes into it. Our NOI explainer covers that.

Key takeaway: you can usually borrow the lesser of what the LTV test allows and what the DSCR test allows. Whichever is tighter sets your loan.

A worked cash-out refinance example

Here’s a simple illustrative example with round numbers. It isn’t based on current rates or any real market.

Year one. You buy a building for $1,000,000. You put down $300,000 and borrow $700,000, which is 70% LTV. The building’s NOI is $80,000.

A few years later. You’ve leased up empty space and improved operations. NOI has grown to $120,000. A new appraisal values the building at $1,500,000. To keep things simple, assume the loan balance is still about $700,000.

Now a lender offers a refinance with a maximum of 65% LTV and a minimum DSCR of 1.25.

1. LTV limit: 65% × $1,500,000 = $975,000.
2. DSCR limit: $120,000 ÷ 1.25 = $96,000 of annual debt service allowed. Suppose, at the lender’s rate and amortization, a $975,000 loan would cost about $85,000 a year. That’s under $96,000, so the DSCR test passes. ($120,000 ÷ $85,000 is about 1.41.)
3. New loan: $975,000.
4. Pay off the old loan: $975,000 − $700,000 = $275,000.
5. Subtract closing costs: say $15,000 for fees, the appraisal and legal work.
6. Cash to you: about $260,000.

You still own the building. You’ve recovered most of your original $300,000, and you can use it as a down payment somewhere else.

What changed for the worse

Your annual debt service went up, so your cash flow after loan payments went down. Your loan is bigger, so your equity cushion is thinner. If the building loses a major tenant, there’s less room before payments become hard to cover.

That’s the trade. A cash-out refi turns equity into cash by adding risk.

The risks of refinancing

Refinancing is a normal, useful tool. It also causes real trouble when it’s pushed too far. Here are the main risks a professional would flag:

• Higher payments. More debt usually means bigger monthly payments, which squeezes cash flow.
• Over-leverage. Borrowing near the limit leaves little buffer if income falls or values drop.
• Interest rate changes. If rates are higher than your old loan’s rate, a refinance can cost you even without taking cash out. Floating-rate loans carry their own risk.
• Falling values. If the market softens, a property can appraise lower than expected, shrinking the loan you can get, or making it hard to refinance a maturing loan at all.
• Prepayment penalties. Many commercial loans charge a fee for paying them off early. These can be large, so check the existing loan before planning a refi.
• Closing costs. Appraisal, lender fees, legal and title costs all eat into the cash you take out.

A note on taxes

Cash-out refinance proceeds are often described as “tax-free” because borrowed money generally isn’t treated as income. That’s broadly true, but taxes still matter: the debt still has to be repaid, and how you use the money and what happens when you eventually sell can affect your tax picture. Rules vary, so real owners check with a qualified tax professional.

How refinancing works in CRE Tycoon

In CRE Tycoon, you start as a broker with $100,000, then buy buildings, fill them with tenants and grow your portfolio over a 10-year career. Refinancing is one of your two big exits from a building. The game puts it simply: “refinance for tax-free cash or sell for the windfall.”

The game lists loans and refinancing among its “real CRE math, simplified” features, and its refinancing is built on a cash-out refi with loan-to-value and debt coverage checks behind the scenes. In practice, the real-world lessons above carry straight over:

• Raise income first. Leasing up and running business plans can raise what a building earns. In real life, more NOI supports a bigger loan through the DSCR test and a higher value through the LTV test.
• Recycle your cash. Refinancing lets you keep a building and still fund your next purchase, which is how a small starting stake turns into a portfolio.
• Respect the debt. More debt means bigger payments. Market cycles in the game can shift conditions, so a career built entirely on maximum borrowing has less room for a bad stretch.
• Compare with selling. Selling hands you a check showing the cash you banked and the profit below it. Refinancing keeps the income stream. The right choice depends on what that building can still do for you before month 120.

For timing ideas, our CRE Tycoon strategy tips cover when to refinance and when to sell. If you’re new to the game, start with the how to play guide.

The short version

Refinancing replaces a loan with a new one. A cash-out refi lets you pull equity from a building without selling it, sized by LTV and DSCR. It’s powerful because it recycles capital, and risky because it adds debt. Try the idea yourself, with no real money on the line, in a free career of CRE Tycoon.

FAQ

What is a cash-out refinance on commercial property?

It’s a new, larger loan that pays off the existing loan and hands the owner the difference in cash. The owner keeps the building but takes on more debt, usually with higher payments.

What is LTV in commercial real estate?

Loan-to-value is the loan amount divided by the property’s appraised value. A $700,000 loan on a $1,000,000 building is a 70% LTV. Lenders set a maximum LTV for each loan.

What is DSCR and why does it matter for a refinance?

The debt service coverage ratio is NOI divided by annual debt service. Lenders use it to check that the property’s income covers the loan payments with room to spare, and it often limits how much you can borrow.

Is cash from a refinance taxable?

In many cases, loan proceeds are not treated as taxable income because they are borrowed money you must repay. Tax rules are complicated and depend on your situation, so check with a qualified tax professional.

When does refinancing make sense?

Owners usually refinance to lower their rate, replace a loan that is coming due, or pull out equity after a property’s value has grown. It makes less sense when the new payments would strain the property’s income.

This article is for education and entertainment, not financial advice.