Commercial Second Mortgage or Commercial Equity Line of Credit – Which is Better?


Commercial real estate investors often ask which is the more appropriate loan for their situation, the Commercial Equity Line of Credit or the Commercial Fixed Rate Second. Both of these loans sit in second lien position behind any existing first commercial mortgage, enabling investors to unlock equity and use those proceeds for other projects. Common uses include rehab capital or down stroke cash for new property acquisitions.The advice on which is the better loan program, depends on how the investor is planning on using the cash proceeds of the loan. We often caution investors to be realistic and thorough about predicting future property value as that has a major affect on potential loan options.For example, if the investor is purchasing a stabilized property and simply wants to pull cash out of an existing property to cover the down payment/closing costs it is often best to go with the Commercial Fixed Rate Second. The primary reason is a result of two factors 1. The subject property is stabilized – therefore has little room for rapid appreciation and 2. Bank restriction on cash out refinances. As of this writing, 95% of all funding sources will not go beyond 75% – 80% loan to value on commercial cash out refinances.Due to these two factors it might be 10 years or more before the value of the subject property catches up and puts the investor in the position to pull enough cash/equity out of the new property to pay off the second position loan. Said in another way, most investors do not want the risk of having a floating rate line of credit for length of time.Just the opposite advice would normally be given to investors purchasing properties that are unstabilized and have solid potential for increased value. So, the recommendation is to go with the Commercial Equity Line. Renovate the property, increase occupancy, increase gross income, etc. which in turn, increases the value of the subject property. Than refinance the first mortgage on the new property via a cash out refinance. Use the proceeds to pay off both the balance on the Equity Line and the balance on the first mortgage of the new property.Why bother? Why not just get a Fixed Rate Second and not worry about having to refinance the debt on the line? or have to worry about the rate increasing on the line? There are typically a couple of good reasons:
1. The rate of the Fixed Rate Second position loan is normally 50 bps to 150 bps higher than on a typical first position loan. By getting an overall lower rate, the investor’s portfolio cash flow should increase.
2. By paying of the balance on the Commercial Equity Line the investor now has access again to capital on the line to begin another project.Of course every situation is different and requires tailored strategies to put the investor in the best position possible. The idea is to just plan ahead and compensate for both the investors comfort zone as well as the restriction that the investor faces when dealing with funding sources.