A Bridge to Success through Short-Term Financing
Originally published on Scotsman Guide
With recent rent and sales-price growth in multifamily housing and other commercial real estate sectors, mortgage brokers and lenders should be paying more attention to the use of bridge loans to help clients in need of short-term financing. Clients use bridge loans to support a project until they can secure permanent financing.
Also known as gap financing or interim financing, these types of short-term loans are popular with clients who are looking to quickly close property acquisitions and execute value-add business plans. These types of loans are often interim financing vehicles for multifamily homes or other commercial-property acquisitions.
Occasionally, such loans are used for cash-out refinance purposes, with the money going for rehabilitations or renovations, lease-ups or interest reserves. With quick closing periods and one- to three-year terms, bridge loans provide temporary financing until the borrower secures a permanent takeout loan with an agency, a bank, a commercial mortgage-backed securities lender or even the U.S. Small Business Administration (SBA).
As mentioned above, a main use for the loan is to put additional funds into rehabilitations and renovations. This allows property owners to raise rents, maximize proceeds and increase bottom-line cash flow which, in turn, increases a property’s overall value. Property owners or investors can then secure permanent financing at the new valuation and pull more cash out when they refinance out of their bridge loans.
Bridge loans have advantages over various loan programs from agencies such as Fannie Mae and Freddie Mac, the SBA and the U.S. Department of Housing and Urban Development (HUD). There may be a variety of situations that necessitate a quick closing, such as a hard deadline or a competitive bidding situation. A bridge loan may close in only a few days or weeks.
Conversely, the lengthy timelines and requirements for loan approvals from groups such as HUD and SBA can impede the timing of transactions. An SBA loan can take up to three months or longer to be approved while some HUD loans can take five months or more. A borrower also may encounter unexpected delays during the permanent loan approval process, which may result from issues with the property title, structural problems, environmental concerns or financial-performance issues.
These are some of the reasons why bridge loans may make sense for clients of commercial mortgage brokers. There are two types of bridge loans that are well suited to meet current market demands, particularly for smaller-balance real estate that is too small for debt funds or other institutional lenders.
First, non-recourse bridge loans are a popular option for properties with some in-place cash flow. These loans require no personal guarantee (other than for so-called “bad boy” acts in which a party prior to closing willfully took part in intentional misconduct). Such loans can allow up to 20% cash out for improvements. Pricing typically starts at the prime interest rate plus 395 basis points, with a loan-to-cost (LTC) ratio as high as 80%.
Second, so-called “performance” bridge loans may be a better fit for quick-close deals or heavier-lift properties that don’t have in-place cash flows. These types of bridge loans can be used for acquisitions, rehabs, refinances and stabilization efforts, with up to 50% available for construction expenses. Pricing typically starts at 5.99% with up to 75% LTC.
Although bridge loans have many benefits, there are some important risks and potential drawbacks for borrowers to consider. Bridge loans typically have higher interest rates than other types of financing. They also are subject to floating rates, which are currently on the rise. For properties that experience a decrease in rent-growth rates, valuations level out after a period of increases. Additionally, lenders generally require strong credit and a certain level of in-place cash flow. If the borrower is unable to repay the bridge loan, the lender may be able to foreclose on the property used to secure the loan.
These types of loans play critical roles in the multifamily housing market, which many experts believe is poised for continued growth in 2022. For instance, Freddie Mac estimates 4% multifamily rent growth across all markets this year. The organization also expects to see overall multifamily origination volume to continue rising.
With rents continuing to climb and interest rates remaining low — but trending upward — investors will want to strike while the iron is hot. Bridge loans can close in less than 30 days, even before the next forecast rise in rates. At the same time, they allow multifamily investors to execute rehab and value-add plans for capitalizing on rent growth.
In addition to multifamily housing, the self-storage, health care and hospitality sectors also may benefit from bridge lending. While many industries have struggled due to COVID-19 cases, self storage has grown as more people transition to remote work or downsize their homes. According to StorageCafe.com, about 53 million square feet of rentable storage space was completed in 2021 alone. As a result, investors are gravitating toward self-storage deals to expand or improve existing operations. Bridge loans provide a deal structure that allows for quick execution, offering advantages for investors.
While the self-storage and multifamily housing markets are on the rise, the health care and hospitality industries are still recovering. There are distressed assets in these sectors that need short-term capital influxes to restore operations. With bridge loans, these businesses can make improvements and stabilize cash flows.
Bridge loans can be a valuable solution when lenders and brokers are discussing investment financing options with their clients. Quick closings, flexibility and non-recourse provisions can fit a variety of business-use cases and provide an influx of cash.
Partnering with an experienced bridge lender can help clients find competitive pricing and attractive deal structures. Select lenders will pay a fee to their referral sources on closed deals. Lenders and brokers should act quickly if their clients meet the requirements for a bridge loan. There’s no better time than now to take advantage as rates begin to rise.