- A bridge loan is a short term loan whose proceeds are used to help investors acquire a property quickly and fund value-add renovations. When it’s term is complete, it is replaced by a permanent loan.
- The primary benefits of using a bridge loan are speed, flexibility, and the fact that they tend to be non-recourse.
- However, bridge loans are more expensive with higher origination fees and higher interest rates.
- If an investor is considering a deal that includes bridge financing, they should carefully review the property’s business plan and the sponsor’s experience working with short term financing to ensure it poses an acceptable risk.
What Is a Bridge Loan in Commercial Real Estate?
With a value-add investment strategy, there are two distinct transaction phases: the value-add phase and the stabilized phase. During the value-add phase, there is a lot of activity around improving the property. This could include things like managing renovations and working with future tenants to negotiate leases. Once these activities are complete, the property moves into the stabilization phase, in which the activities are focused on managing the property and ensuring it stays full.
In a scenario like the one described above, the financing needs are very different for the two phases. The value-add phase has a relatively short term at 1-2 years, while the stabilized phase has a much longer term, often up to 10 years. For these reasons, it is not uncommon for real estate investors to obtain a short-term loan for the acquisition and value-add phase, and then refinance into a longer-term loan once the property is stabilized. This is where a commercial bridge loan comes into play.
Commercial Bridge Loans – Defined
By definition, bridge financing is a short-term financing option designed to assist the borrower in getting from one stage to another. In the case of a value-add transaction, it is designed to provide financing for the acquisition and value-add phase. Once the property is stabilized, the bridge loan is paid off with long-term financing that could be provided by the same lender or a different one.
The actual terms for commercial bridge loans can vary widely, but they typically fall within the following ranges:
- Lender: Traditional bank or private money
- Term: 12 Months to 36 Months
- Interest Rates: 6% – 12%
- Payment: Interest-only monthly with balloon payment at maturity
- Fees: 1% – 2% of the loan amount
From a risk standpoint, commercial bridge loans have more risk for bridge lenders, so there are higher interest rates and higher upfront fees. But, this type of financing can be very useful under the right circumstances.
Benefits of a Commercial Bridge Loan
While there are many benefits to using a bridge loan to finance the purchase of a commercial real estate investment property, there are two that are most significant:
- Speed and Flexibility: Commercial bridge loan approval requirements tend to be less stringent than those for a permanent loan. For this reason, this option can allow investors to move quickly to purchase a property before it is placed under contract by another investor or competitor. Where it may take 30 days or longer to approve permanent financing, a bridge loan can be approved in less than a week. This type of speed provides investors with the liquidity and flexibility that they need to move quickly to close on the most promising deals.
- Recourse: Most permanent commercial loans require the borrower(s) to provide a personal guarantee for the balance. However, commercial bridge loans are based on the amount of cash flow a property produces, not the value. For this reason, bridge lenders do not require a personal guarantee, which makes the loan less risky for the borrower.
While these benefits can assist borrowers and investors in moving quickly to close on a property, they aren’t without risk.
Risks of a Bridge Loan
Likewise, there are two risks that must be considered when pursuing bridge financing:
- Cost: When compared to more traditional financing options, there is no doubt that commercial bridge loans are more expensive. They have higher interest rates and higher fees. As a result, property returns can be impacted.
- Execution Risk: Bridge loans have a relatively short term, which means that value-add activities must be completed within a relatively short window of time. If there are unanticipated delays or the property does not lease as quickly as expected, repayment of the bridge loan can be jeopardized because the property does not have enough cash flow to support a long-term mortgage. If this were to happen, borrowers may need to seek a loan extension, other interim financing, or they could exhaust their operational reserves trying to support the property.
There is no doubt that a bridge loan raises the risk profile of a transaction but, not to an unacceptable level. For investors reviewing a potential deal with a commercial bridge loan, there are several important factors to consider.
Factors to Consider in a Deal With a Bridge Loan
From an investor standpoint, it is not uncommon to see a private commercial real estate transaction that includes some sort of bridge financing. When this is the case, there are three items that investors should carefully consider:
- The Business Plan: What is the plan for the real estate bridge loan proceeds? Are they going to be used for acquisition and renovations? Does repayment depend on a fast lease-up of the renovated property? Are the leasing assumptions supported by market data? Has the sponsor allocated enough time to complete the renovations? Has the sponsor included some contingency time in case there are delays? What is the LTV at origination? Is the property loaded with too much debt?
- Permanent Financing: What are the assumptions used for the permanent loan? Are they consistent with terms widely available in the market? Does the sponsor have a term sheet from a permanent lender? What is the interest rate forecast for the term of the bridge loan? Has the sponsor performed a “sensitivity” analysis to determine what interest rate could cause the loan to no longer be feasible?
- Experience: Does the sponsor have experience with this sort of financing arrangement? Does the sponsor have established relationships with permanent lenders and a long track record of doing deals with them?
The above factors must be considered to assess the risk that the commercial bridge loan might not be able to be refinanced when its term is up. If the business plan is reasonable and the permanent financing assumptions are conservative, a bridge loan can be an effective way to acquire a property quickly, improve it, and refinance into a long-term loan.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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