Sell or refinance your apartment building? How to compare them
Refinance when you want to keep the building and the income supports a loan larger than what you owe. Sell when you want out, or when today’s rates mean a refinance would require a paydown. The comparison comes down to three numbers: what a buyer would pay, what a new loan would be, and what you owe.
Step 1: what the new loan would be
Lenders size a refinance on the lower of two tests: a share of value (Fannie Mae’s conventional term sheet caps it at 80%) and debt service coverage (at least 1.25x on Fannie’s and Freddie Mac’s term sheets). At a 6.75% loan rate and a 6% cap rate, for example, the coverage test binds first. The worksheet shows which one limits your loan and by how much.
Step 2: compare with what you owe
If the new loan is bigger than your balance plus costs, the difference is cash out without a sale. If it’s smaller, you’d have to pay the loan down to refinance, which is when owners facing a maturity start thinking about a sale.
Also read your current loan’s prepayment terms. Agency loans often carry yield maintenance or defeasance, which can make paying off early expensive. Fannie Mae’s conventional term sheet lists yield maintenance for fixed-rate loans, and Freddie Mac’s fixed-rate term sheet lists yield maintenance until the loan is securitized, then defeasance. Your loan documents control.
Step 3: what selling nets you
Price minus the loan payoff (including any prepayment cost), minus broker and closing costs, minus tax. A sale can trigger capital gains tax and recapture of depreciation you’ve taken; a 1031 exchange can defer that if you buy another property under the IRS rules. Get a tax adviser’s number before you compare; this isn’t tax advice.
A quick way to decide
- New loan exceeds what you owe, and you want to keep owning: refinance, and see what the cash-out does to your coverage.
- New loan falls short, and you have cash to pay down: refinance may still work, with a smaller loan.
- New loan falls short and you’d rather not add cash, or you’re ready to be done: price a sale.
The worksheet gives you the first two numbers in a few minutes. To test a refinance with lenders, send the building to the desk. For a sale, talk to a licensed investment sales broker of your choosing.