Bridge loans. You’ve heard about them, you kind of understand what they are, but you’re not clear on the details or if one is right for you? This article will hopefully clear up some of the ambiguity surrounding Commercial Real Estate (“CRE”) bridge loans and answer any unanswered questions.
What is a commercial real estate bridge loan?
A commercial real estate bridge loan typically has a 1-5 year term and is intended to transition an underperforming property into one that has reached full potential. This is achieved through a multiple-advance loan structure that commits money up front to cover the cost of the purchase or refinance, and then future monies for leasing costs and capital expenditures needed to maximize the income generated by the property. That unique structure is what makes a bridge loan.
Would a bridge loan be right for your deal?
You find yourself involved, or at least interested, in purchasing or refinancing commercial property. You’ve made the decision to finance a portion of the investment with debt, and you require a loan, but you don’t need the loan for a long period of time. A bridge loan could be the solution.
Bridge loans have a special place in the commercial real estate finance ecosystem. They exist, as the name suggests, to bridge your investment over a transitional period. There are many reasons commercial real estate borrowers or sponsors look to a bridge loan for their financing needs. Some of them are:
- To execute a value-add business plan by investing accretive capital over a transition period (involving, e.g., leasing costs, capital expenditures, entitlements, operational improvements, etc.) to create additional value before exiting through a sale or recapitalization.
- To allow for flexibility in a business plan, where the ultimate direction of an asset is still undecided, and you need more time to determine the desired outcome, but you don’t want to secure a long-term debt product that limits near-term flexibility.
- To bridge a period in an asset’s lifecycle when there are potential near-term interruptions in cash flow, such as lease expirations, that coincide with a maturing mortgage. To get past that period, a bridge loan is an appropriate solution until the asset can return to a condition where future cash flow is better defined and you are in a better position to sell or recapitalize the property.
- To allow additional time for an asset to demonstrate a profitable operating history (aka seasoning), a sponsor may secure a bridge loan to develop such a track record before seeking long-term financing or disposing of the asset.
- Where CRE sponsors have a blemish in their history that could interfere with their obtaining a permanent loan promptly, a bridge loan can serve in the short and mid-term to buy the borrower time, by creating a distance between the blemish and the quest for long-term financing.
There are a multitude of other scenarios I’ve encountered over the years that would make themselves ideal candidates for a bridge loan. Most, if not all, have a transitional characteristic.
How is a bridge loan different from other types of commercial real estate loans?
Term or Duration
The term of a loan is one very general way in which different types of loans are distinguished. Unlike fixed-rate, permanent financing, which can have terms from 5 to 20 years or more, a bridge loan is generally for a shorter period, with terms typically ranging from 1 to 5 years. Loans shorter than this are often called hard-money loans. Most bridge loans today have an initial term of 2 to 3 years, with extension options in the event that additional time is needed to execute the borrower’s original business plan.
Interest rates for bridge loans vary widely. The upper end of the range is generally much higher than a permanent, fixed rate loan would be, but not as high as some hard money loans. The inverse can be said of interest rates for those types of loans on the lower end with bridge loan interest rates typically higher than fixed rate loans and lower than hard money. While risk is also a significant factor, the various interest rates have a high correlation with the duration of a loan as well. Interest rates today on traditional bridge loans range between 3% on the very low end and 12% on the high end. As you can see, the range is substantial. It is highly dependent on the characteristics of the loan opportunity.
Bridge loans can have fixed rates, floating rates, or in some cases a hybrid that includes caps or other derivative formulae, depending on complexity. Most often you’ll see bridge loans quoted on a floating rate basis, given the short-term nature of the product and the comfort that both lenders and borrowers typically have over such a period.
Bridge loans come in many different forms and have a variety of structures. Typically, a bridge loan will have a multiple advance structure where, in the case of a value-add strategy, some of the money to be advanced is held back from the initial loan proceeds to fund activities that will improve the value of the property. So, in the event you’re acquiring an asset, the bridge lender would typically fund a portion of the upfront acquisition cost but then hold back 100% of the anticipated costs to lease-up the property or improve it, or sometimes both. However, some assets already have stabilized occupancies and do not require any improvements. In these situations, the bridge loans will only include a single advance.
Advance Rates or Loan-to-Value
Advance rates for typical bridge loans may vary from lender to lender. On the more conservative side of the lending spectrum, you’ll see advance rates capped around 65% of the property’s value and, on the more aggressive end, they can reach ratios of around 85%. All things being equal, the pricing on a specific asset rises substantially as the ratio of the loan size to the value of the property increases.
There are many other factors unique to bridge loans that you’ll want to consider as well when seeking one out. These include, for example, origination and/or exit fees, follow-on funding, reserves, cash-management, recourse provisions, draw processes, etc.
Is a bridge loan right for you?
There are many advantages to using bridge loans. They offer sponsors greater flexibility than permanent loans, which can have very stringent lockout provisions and prepayment penalties. Bridge loans, by contrast, can, if you have early success in your business plan, generally be retired much sooner -- often without penalty. This is important when a CRE sponsor anticipates a short transition period for an asset to return to optimum performance, at which time its sale or recapitalization would make the most sense. Bridge loans also are useful with seasoning strategies where, for example, you need a 12-24 month operating history before you bring an asset to market for sale or recapitalization.
A bridge loan is also superior to a permanent loan because it gives a commercial real estate sponsor time to execute a transitional business plan with assurance that the plan is fully capitalized. With a bridge loan, a reliable lender has from the start committed capital for future leasing costs and planned capital improvements. Typically, equity isn’t as efficient, it’s more expensive and is not well suited to accommodating multiple advances.
Another advantage of a bridge loan over permanent debt during a transitional period is that payments are typically interest-only during the loan’s initial term. There are no amortization or principal payments required. This accommodation accords with the transitional nature of the bridge loan and an understanding that cash flow is typically depressed or uncertain during this period. Thus, paying down principal is secondary to executing the value add investment strategy.
Where can I get a bridge loan?
Bridge loans for commercial real estate can be sourced from a variety of capital providers, including banks, insurance companies, credit unions, mortgage REITs, and debt funds. They can also be sourced through intermediaries such as commercial real estate mortgage brokers, who have access to a variety of resources and contacts that can help you find the best bridge lender to fit your needs. Unless you have a well-established relationship with a lender, and even if you do, an experienced commercial mortgage broker is an excellent resource for getting lenders to compete for your business with a customized solution to fit your specific business plan.