Modeling a Refinance

Modeling a refinance in your underwriting adds another layer of uncertainty.

Doesn’t mean it’s wrong.

But here’s what you need to know:

When to Model a Refinance:

Certain business plans almost always require a refinance and would be appropriate to put in your underwriting model.

A few examples would be:

  • Ground Up Development
  • Value-Add
  • Long Term Hold

Take for example, a ground up development. The main objective is to build the project and refinance out of the expensive construction loan as quickly as possible. A developer would always plan to refinance (or sell) once their project is stabilized.

How To Underwrite a Refinance:

Getting this part right is critical.

Here are 3 ways you can model a conservative refinance:

  • Expand your cap rate.
  • Use a higher than expected interest rate.
  • Verify your DSCR

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. The cap rate and your desired loan-to-value percentage determine the loan amount.

Interest Rate:

Similarly, investors have no way to predict where interest rates will be years out in the future. There is no simple answer to this, but it would be conservative to model a higher interest rate than what you expect.

DSCR:

For the month you are refinancing, be sure to pay close attention to your DSCR with the proposed refinance loan amount. The loan will be DSCR constrained at the time of the refinance so shooting for a 1.25x – 1.35x (with conservative projections) will set you up for success.