Many owners with a loan coming due are in an unfamiliar position: rents are higher than when they borrowed, the building is full, and the refinance still does not cover the balance. The usual cause is not the property. It is that the cap rate applied to the income is higher than it was when the loan was made, and the payment on a new loan is higher too. The math is simple enough to run yourself, and running it early is what gives you options.
Why value can fall while income rises
Value on income property is net operating income divided by the market cap rate. If the cap rate rises faster than your income does, value falls. The full mechanics are in our cap rate guide; the short version is that at low cap rates, a one-point increase removes a large share of value.
A maturing loan is exposed to this twice. The loan-to-value limit is measured against today's lower value, and the coverage test is measured against today's higher loan payment.
A worked example
Illustrative example. Not an offer or a completed transaction.
When the loan was made. An apartment building had NOI of $150,000. At a 4.75% cap rate it appraised for about $3,158,000, and the owner borrowed about $2,050,000, or 65% of value.
Today. The owner has raised NOI by 10% to $165,000 and paid the balance down to $1,950,000. The loan matures in nine months. Comparable buildings now sell at about a 5.75% cap rate.
- Value: $165,000 ÷ 0.0575 = about $2,870,000. At the old 4.75% cap rate the same income would have been worth about $3,474,000.
- Loan-to-value: $1,950,000 ÷ $2,870,000 = 68%. A lender limited to 65% would offer about $1,865,000, leaving a gap of about $85,000 before closing costs.
- Coverage: at an assumed 7.0% rate on a 30-year amortization, payments on $1,950,000 are about $155,700 a year and the DSCR is $165,000 ÷ $155,700 = 1.06. A lender requiring 1.25 would offer about $1,653,000, leaving a gap of about $297,000.
The owner did everything right and still faces a shortfall of roughly $297,000, because coverage, not value, is the tighter test. To support the full $1,950,000 at a 1.25 DSCR on those terms, NOI would need to be about $194,600, or roughly $29,600 a year more than today.
The same building underwritten interest-only. A lender that underwrites interest-only payments to a 1.0 DSCR at an assumed 8.5% rate would size coverage at $165,000 ÷ 0.085 = about $1,941,000, within about $9,000 of the balance. Coverage is no longer the problem. The value test now is: at a 65% limit the loan is still held to about $1,865,000, so the gap shrinks from about $297,000 to about $85,000. The trade is a higher rate, no cushion and no principal paydown.
The interest rates, amortization, loan-to-value, coverage and debt yield figures used here are assumptions chosen to show the math. They are not quoted rates or program terms. Actual rates and limits vary by lender, property, borrower and program and change with the market.
Find your break-even cap rate
You can test your own loan for the value problem in one line:
Break-even cap rate = NOI × maximum loan-to-value ÷ loan amount needed
In the example, $165,000 × 0.65 ÷ $1,950,000 = 5.5%. If buildings like yours are selling at cap rates above 5.5%, the loan will not fit on value. If they are selling below it, value is not your problem and you should check coverage next:
NOI needed = loan amount × annual loan constant × required DSCR
The loan constant is one year of payments divided by the loan amount: about 0.0798 for a 7.0% rate on a 30-year amortization, or simply the interest rate on an interest-only loan.
Use underwritten NOI in both formulas, not your own figure. The difference is explained in how lenders calculate NOI, and the way the tests interact is in cap rate, DSCR and debt yield.
Options for closing a gap
| Option | When it fits | What to weigh |
|---|---|---|
| Raise NOI before applying | There are below-market rents, vacant units or expenses that can be cut within a few months | Lenders want to see the higher income in collections, not in a projection, so it takes time |
| Pay the loan down at closing | The gap is modest and you have liquidity | Ties up cash; compare with the cost of the alternatives |
| Ask the current lender to extend or modify | The loan has performed and the lender prefers not to force a payoff | Often requires a paydown, a fee or new terms, and is at the lender's discretion |
| Use a program underwritten differently | Interest-only underwriting to a 1.0 DSCR can support more loan than amortizing underwriting to 1.25 | Higher rate, no cushion and no paydown; compare the full cost, not only proceeds |
| Bridge loan, then refinance | Income is rising through lease-up or renovation and needs 12 to 24 months to show | Higher cost for a short period, and you need a credible plan for the permanent loan afterward |
| Bring in a partner or sell | The gap is too large for the other options | Gives up ownership or the asset, but on your timing rather than the lender's |
These can be combined. A modest paydown together with a few months of rent increases is often enough to move a loan from not fitting to fitting. Blue Fox Capital Corporation arranges both amortizing and interest-only structures; the side-by-side math is in cap rate, DSCR and debt yield. Where income is still on its way up, see commercial bridge loans; for stabilized buildings see commercial mortgage loans and multifamily and mixed-use loans.
A timeline that keeps you in control: our approach
- 12 months before maturity. Rebuild NOI the way a lender will and run the break-even cap rate and coverage formulas. If there is a gap, this is when raising NOI is still possible.
- 9 months. Read the loan documents for extension options, prepayment terms and notice dates. Ask the current lender, in writing, what it would consider.
- 6 months. Assemble the package and get it in front of lenders. Our checklist for a commercial loan coming due lists the documents.
- 3 months. Appraisal, third-party reports and closing. A gap discovered at this stage leaves few choices other than a paydown or an expensive short-term loan.
The owners who end up with the fewest options are the ones who learn the value from the appraisal. The ones with the most are those who ran the numbers a year out.
Frequently asked questions
Why is my refinance smaller if my rents went up?
Value depends on both income and the cap rate, and the loan also has to cover a payment at current interest rates. If cap rates and rates have risen faster than your income, the supportable loan can be smaller than your balance even with higher rents.
What is a break-even cap rate?
It is the highest market cap rate at which your loan still fits the lender's loan-to-value limit. Multiply underwritten NOI by the maximum loan-to-value and divide by the loan amount you need.
How early should I start on a loan that is maturing?
We suggest running the numbers about 12 months before maturity. That leaves time to raise income, negotiate with the current lender or arrange a different structure. Starting 90 days out leaves few choices.
Will my current lender extend the loan?
Some will, at their discretion, often with a paydown, a fee or changed terms. Read the loan documents for any built-in extension rights and ask early, in writing.
Is a bridge loan a good way to handle a maturity?
It can be when the property's income is clearly improving and a permanent loan will fit once that income is in place. It costs more than permanent financing, so it should come with a realistic plan and timeline for the refinance that follows.
Loan maturing in the next 12 months?
Send the maturity date, current balance, rent roll and operating statement, and we will review the refinance and bridge options that may fit. Term sheets are subject to review and lender approval and are not a commitment to lend.
Blue Fox Capital Corporation arranges and places financing for real estate investors, commercial property owners and California homeowners. Blue Fox Capital Corporation is a licensed California mortgage broker (DRE 01527288, NMLS 1840487). On select correspondent loan programs it is the direct lender named on the loan documents. We confirm the role for your loan before anything is submitted. Daniel Eckhouse, NMLS 217328 | CA DRE 01977403. This article is general information, not an offer, a rate quote, a loan approval, an appraisal or legal, tax or investment advice for your situation. Examples are illustrative only and are not completed transactions. Market figures are from the sources and dates cited and may have changed. Programs, terms and availability vary by property, borrower and lender and are subject to qualification and lender approval. Not all applicants will qualify. The business-purpose loans discussed are not available for a home you live in or plan to live in. Equal Housing Opportunity. 4695 MacArthur Court, 11th Floor, Newport Beach, CA 92660 | (310) 756-3619 | dan@bluefoxcapital.com