Everything You Need To Know About Bridge Loans
Flexible Financing: Bridge Loans
Suppose you want to buy a property for $10,000,000. A quarter of that will come from equity sources including friends, family, business partners, real estate investors or crowdfunding and your own vested interest in the property. But what about the other 75%? There are so many different financing options that it may be tough to determine which makes the most sense. Bridge debt may be a viable option depending on your situation. Let’s take a deeper look…
What is Bridge Debt Financing?
According to Investopedia, a bridge loan is defined as a “short-term loan that is used until a person or company secures permanent financing or removes an existing obligation.” This type of financing is secured by the real estate asset, usually requires cash flowing assets and the loans tend to be floating rate and may have a higher interest rate than comparable permanent debt. The loan is characterized by shorter term and may include structuring or future funding to facilitate the costs of repositioning of the property.
How is Bridge Debt used in Real Estate?
For real estate, bridge loans may be used for a variety of reasons which could include purchasing a property under a tight closing timeline, renovating and selling a property over a shorter time period (such as a quick fix and flip), or retrieving properties from foreclosure. Other uses for real estate bridge loans could include finding a new tenant, stabilizing the cash flow of the property, or resolving a short term issue affecting the property (such as environmental issues) or the creditworthiness of the borrower that would prevent the borrower from obtaining permanent debt on the property. Bridge loans typically have terms between 2-3 years and are paid back upon the property being sold or refinanced.
Examples of how a Borrower could use Bridge Debt:
|Borrower plans to renovate 50% of units at the property by installing new kitchen appliances, granite countertops, new flooring, paint, etc. Upon completing the renovations, the Borrower would be able to raise rental rates given the higher quality of finishes.
|Depending on the type of office building, a Borrower may plan to lease up the property and sell the asset. The Borrower could use bridge debt to help fund the tenants fit out of their space.
|If a Borrower plans to purchase a retail center at a discount, hold onto the asset for a short time period and then sell it, a Borrower may elect to use bridge debt to quickly close on a property, hold the property for 2-3 years, and then sell.
|A Borrower may want to get a bridge loan on an industrial building or industrial portfolio to renovate suites to be more in line with what the market is looking for, i.e. more flexible space or larger tenant suites vs smaller ones.
|A Borrower may want to get a bridge loan on a hospitality property in order to stabilize cash flows prior to refinancing the property with permanent debt.
PROS of Bridge Financing
The main benefit of bridge debt financing is flexibility. It provides borrowers with short term capital that allows them to meet any current expense obligations, quickly close on properties, complete renovations, or allow the Borrower to find new tenants for the building.
Additionally, most bridge loans are non-recourse, which means the Lender can only seek repayment of the loan through the property itself. The Borrower personally has no financial responsibility to pay back the loan and the Lender cannot seek compensation even if the value of the property does not cover the remaining loan balance. Given the current state of the real estate industry, it can be a very attractive form of financing.
CONS of Bridge Financing
The biggest disadvantage of using bridge financing is also what makes it the most appealing. With flexibility comes a steeper price tag as interest rates will be higher on bridge loans than permanent financing from a traditional lender. Coupled with shorter loan terms, the payments are typically higher than permanent financing. Additionally, because of the short term nature of the loan, lenders will typically be less flexible when it comes to late payments by charging larger fees and penalties.
In addition to being more costly, the short term nature of bridge loans relies on take-out financing, i.e. permanent debt or the property being sold, which the availability in the market place is not always guaranteed. During the recent financial crisis, capital in the market dried up and it made it harder for Borrowers to get take-out financing. This led to delays in conversion to permanent debt, lowered anticipated returns and in extreme instances resulted in defaults.
What Did We Learn?
Bridge debt is a flexible financing option that gives borrowers access to money to cover short-term expenses or to take advantage of a short term opportunity. Although there are some disadvantages to using bridge debt, there are considerable advantages and depending on your situation, may be the perfect fit to execute your business plan.