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Modeling a refinance in your underwriting projections adds more uncertainty to the deal.

In a business plan where a refinance is needed, such as a ground up development deal, there are a few things you can do to model a realistic refinance.

Expand Cap Rate

The refinance loan proceeds will be determined by the market cap rate of your property. Nobody can predict where cap rates will be next month, let alone several years from now. Always underwrite to a higher than anticipated market cap rate.

Verify DSCR

Most permanent financing debt options require a DSCR of at least 1.25. For the assumed refinance month, verify that you have at least a 1.25 DSCR in your projections. You may want to verify how your DSCR looks with an interest only and fully amortizing loan.

Ultimately, your loan proceeds will most likely be DSCR constrained. Meaning, the lender could allow up to 75% LTV, but will only provide a loan the project can support (usually 1.25 DSCR or higher!).

Stress Test

When underwriting a refinance, it’s important to run stress tests to view different scenarios. What happens if expenses were to increase 15%? How do proceeds look if interest rates increased?

With your refinance projections, always try to under-promise and over-deliver. Add cushion in your refi projections so the deal isn’t heavily reliant on optimistic refinance assumptions.

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📈 Chart of The Week

Close to USD 820 billion of U.S. commercial-property loans could mature in 2024, coming due after a broad decline in property prices and sharp increase in borrowing costs that may stymie the refinancing of some mortgages. Loans maturing in 2024 total around USD 600 billion, according to MSCI Mortgage Debt Intelligence data.

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