A short-term bridge loan is a type of mortgage that provides borrowers with short-term capital that can be used to purchase and/or improve a commercial property until the property is repositioned and then refinanced or sold. The borrower will use the proceeds from the refinance or sale to pay off the short-term bridge loan at that time.
Short-term bridge loans can be used for all property types, including multifamily, office, industrial, retail, hotel, self-storage, mobile home parks and land development.
Private bridge lenders are typically able to provide highly customized loans with rapid speed—something that most traditional lenders cannot offer.
What are the typical terms of a short-term bridge loan?
Most bridge loans are structured to be short-term, usually three years or less (sometimes with two one-year options to renew). As the name implies, they are intended to provide “bridge” capital to get a borrower from one source of financing to another.
Bridge loans usually have higher interest rates than traditional commercial loans. The rates are generally 50 to 200 basis points higher than you might expect with a conventional bank loan, with the actual rate depending on the specifics of the deal. Highly levered or otherwise higher-risk deals will generally have higher interest rates, and vice versa.
How can bridge loans be used for commercial real estate?
Short-term bridge loans can be used for a variety of commercial real estate purposes. These are the most common reasons for using a bridge loan:
1. You need access to capital quickly.
Time is money—and a bridge loan can help a borrower move forward faster than if they were to try to line up traditional financing. Short-term bridge loans are one of the easiest and most secure ways of financing short-term projects. Some bridge loans can be closed and fully funded in a month or less compared to a traditional lender, where loans generally take at least 45 to 60 days to close. The fast processing time of bridge loans is a major advantage to this type of financing.
2.Your deal is unconventional.
Bridge loans are highly flexible in nature, and therefore, are a great source of financing when someone has an unconventional deal. This might include the purchase and renovation of a sober living facility or senior living center. These properties are generally difficult to finance and come under great scrutiny by traditional lenders. Whereas traditional lenders have more restrictive loan terms that usually require loan committee approval, bridge lenders can be nimbler and provide terms that are customized to the deal in question.
3.Your value-add strategy forecasts strong future cash flows.
A common real estate investment strategy is to buy a Class B or C property and then execute a “value add” strategy that improves the property to Class A or B quality. Value-add strategies require some combination of physical and operational improvements that together, help to stabilize the property. Repositioning efforts like these are ideal for value-add investors whose business plan anticipates strong future cash flows and increased property value. Unlike conventional lenders who prefer to finance stabilized properties, bridge lenders are usually more comfortable taking on the risk associated with lending on a deal based on future cash flows (something that can be projected but never guaranteed).
4.You need a non-recourse loan.
There are two types of loans: recourse and non-recourse. Recourse loans require that a borrower put up sufficient collateral to make the lender whole in the event of default. This could include a borrower’s other investments, retirement accounts, cash reserves and more. Non-recourse loans, on the other hand, limit the borrower’s liability to the commercial property being financed. Most borrowers prefer non-recourse loans as there is no burden of repaying the loan using other assets unrelated to this deal.
5.You have poor credit.
Short-term bridge loans are excellent solutions for sponsors with credit scores that do not meet the thresholds of a conventional lender. While a bank or agency lender (e.g., Fannie Mae or Freddie Mac) might not approve a loan for this reason, a bridge lender is usually more willing to work with someone regardless of their credit score or credit history. A bridge lender’s underwriting process leans heavily on the value of the asset and less on the credit profile of the borrower.
Real World Bridge Loan Scenarios
Example 1: Buying an underperforming multifamily building.
Let’s say you are looking to buy a 150-unit apartment building that is running at a 70% occupancy rate. The asking price is $20 million. You believe that the property has been mismanaged and that making roughly $5,000 worth of cosmetic improvements to each of the units will stabilize the property and generate significantly more cash flow. You believe that these improvements will cost less than $1 million all-in, and in turn, will make the property worth closer to $30 million. A traditional lender might not be willing to make a loan on the property given its in-place cash flow, especially if you (the borrower) does not have a proven track record in the value-add investment space. This is where a bridge loan might make sense.
In this case, a bridge loan can be an attractive option. A commercial bridge loan worth $21 million would be enough to cover the acquisition as well as the improvements. You anticipate it taking 8-12 months to finish the renovation, at which point you would refinance the property. At a 75% loan-to-value ratio, you would be able to get a traditional loan for $22.5 million, which would be enough to pay off the $21 million bridge loan while still generating a profit.
As you can see here, another benefit to the borrower is that they will not have their own equity at stake. The bridge loan will fully fund the acquisition and renovations. Upon refinancing, the borrower will walk away with roughly $1.25 million in profit and will then have 25% equity in the deal upon stabilization.
Example 2: Renovating a hotel property during a global pandemic.
Here’s an example that we’re personally familiar with. Two multifamily investors decided to purchase a small, 30-key hotel in February 2020. They were in the midst of securing a traditional bank loan to purchase and improve the property, but when the global travel industry virtually shut down in March 2020, the lender pulled back. The lender became wary of the deal given state mandates to shelter-in-place, and was concerned that the investors would have trouble executing their business plan given their lack of experience in the hospitality industry.
Instead, the borrowers turned to a bridge loan to complete their financing needs. The traditional lender still offered a 60% loan-to-value mortgage (down from the originally proposed 80%) and then the borrowers used a bridge loan to finance the balance of the acquisition cost plus the anticipated costs of renovation.
In this scenario, the bridge lender was drawn to the deal for a few reasons. First, the investors planned to use the pandemic-induced shutdown to complete the renovations with record speed. Rather than renovating one or two rooms at a time, they were able to shut the hotel down and renovate all at once. This allowed the hotel to reopen faster and to essential workers who were working at naval base nearby. What’s more, the bridge lender was able to offer the borrowers a six-month interest only period to help them get through the shutdown and renovations—with the option for a second six-month IO period if travel restrictions had not yet been lifted.
The borrowers have since renovated the hotel completely and are booking out with anticipation of a strong spring and summer season. The borrowers expect to refinance the property and repay the bridge loan in full later this year. Had the bridge loan not been an option, the deal would have virtually fallen apart just as it was about to close.
Is a short-term bridge loan right for you?
Any commercial real estate investor will want to weigh the pros and cons of bridge loans carefully. While bridge loans are an excellent source of capital under certain circumstances, they do not come without their own risks. We noted their higher-than-market interest rates, but they also tend to charge steep fees for late payments. They also assume that more permanent financing will be available upon stabilizing the property, which is usually but not always the case—it really depends on the deal specifics. If you are not highly confident in your business plan and exit strategy, a bridge loan might not be best for you. You must be able to execute on time and within budget.
That said, for most borrowers in need of short-term capital, bridge loans are an attractive option. As you’ve seen here, they can be used for a range of situations. They are especially useful for experienced value-add investors who have a clear path forward in terms of improving and repositioning their property.
As always, borrowers should consider all of their financing alternatives before making a decision. When in doubt, consult with several lenders to explore your options.
Interested in learning more about how a bridge loan can support your CRE business? Contact us today!