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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   September 2003

Bridge Loans: The Best Financing Tool for Some Difficult Situations

People who invest in income-producing commercial real estate often are required to manage some challenges that impact the situation. They may include some of the following:

  • High vacancy
  • Change of use
  • Poor physical condition 
  • Lack of adequate seasoning
  • High vacancies
  • Partnership liquidation
  • Incomplete financial reports
  • Receivership
  • Debt buy-down opportunity 
  • Debtor-in-possession
  • Foreclosure 
  • Chapter 11 Bankruptcy filing
  • An immediate need to refinance due to a maturing loan

Or, as a purchaser, they see the opportunity to make a below market acquisition thereby creating new value if financing can be arranged quickly. In any of the above situations, a bridge loan may be the best and the only option. Here’s a quick look at some bridge loan basics:

Bridge Loan

A bridge loan is a short-term loan on a property that for a variety of reasons does not (yet) qualify for a conventional or permanent loan. Generally, bridge loans are risky for the lender, since the property, which is the primary collateral, as a result of the various problems, may not be sufficiently stabilized, and revenues therefore are not yet reliable. This short list illustrates some of the more obvious problems, although the “hair” on the deal will range widely. The problems that plague the loan may involve the property, the borrower, or the transaction itself. Often, the problems involve a combination of all three. 

Security

A bridge loan is usually secured by a lien on a property, supplemented by a lien on a property’s revenue stream, the net operating income as well as any other significant assets. The security is usually in the form of a first mortgage lien on the fee, an assignment of leases and rents, as well as a pledge of the ownership/partnership interests. Also, most bridge loans are full or partial recourse to the borrower, individually, as an additional guarantor. The cash equity invested in a project along with the willingness of an owner/investor to guarantee the loan is obvious evidence of his/her faith in the success of a project. Bridge loans can also be made on properties that are not producing income, yet. If, based on market information and borrower credentials, the short-term lender can be convinced of the ultimate success of a project, (and thereby a satisfactory exit strategy) loans may be made on properties that do not have a revenue stream. Such properties might include a subdivision for single family home development, a condominium for sale or other property conversion, or similar commercial transactions. In some cases, a bridge loan may be for completion of failed construction, or ground-up new construction. 

NOI

The net operating income (usually “NOI”) for a bridge loan may be determined differently from that for a conventional, or permanent, loan. The bridge may not require institutional levels of management fees, often 4 to 6%, but may permit a lower percentage charged in the instance of an owner-operator during the bridge loan term. It is unlikely that the bridge lender will require a set-aside for reserves for replacements or other later scheduled, capital improvements (assuming the requirement is not immediate). However, routine utility costs, contracted expenses, administration, repairs, maintenance, real estate taxes, and insurance are included in the calculations for a bridge loan’s NOI.

Typical Terms

Bridge loans may range from 3 to 36 months. Usually they have a term (balloon) of a year, and are sometimes renewable for a second or third year. In most cases, there is a single closing for the initial term, but additional fees are charged for each renewal or extension.

Typical Rates

Bridge loans are more expensive than conventional loans, often pegged at Prime plus 6 to 8 points, interest only, without amortization. Interest payments can be monthly, quarterly, or on any schedule that suits both parties. However, in some cases, the excess cash flow from the property (after operating and fixed expenses, and interest on the debt), may be “swept” monthly. All of the excess is applied to rapidly reducing the principal. This procedure ensures that the bridge loan’s principal balance, at the end of the term, will be low enough for a permanent loan pay-off.

Typical Loan Amounts

A bridge loan seldom leverages the property as highly as does a conventional loan; (usually 50% to 65% Loan To Value for a bridge, as compared to 70% to 85% LTV for a permanent loan). The higher risk involved with a bridge loan is the reason for the lower loan to value. The usual maximum bridge LTV is 65% to 70% of the appraised and/or market value, whichever is lower. Since this is at the low end of the LTV range for most properties, it is expected that the amount of the conventional loan should take out the remaining principal balance of the bridge if the property is properly leased, managed and maintained during the term of the bridge loan. There is no “lowest” loan amount, since, in addition to private companies, there are many individuals in the short-term lending business who will make very small loans. The highest loan amounts are based on the overall quality of the deal, which is likely to interest major institutional lenders who make loans in the hundreds of millions.

Points

Points for bridge loans range from 3% to 8%, and can be higher. Since these are risky loans, lenders require a high return to justify this underwriting. Sometimes, an investor will finance all, or a portion, of the points and other closing costs. This depends on the maximum loan amount and the application of loan funds. Therefore, a borrower must be able to afford to pay for third party expenses, legal and closing costs, as well as the points that are not financed. 

Prepayment

Bridge loans usually must run the full initial term. The lender wants the yield that was originally calculated at the time of underwriting, and a prepayment will cut into this yield. Therefore, there will usually be a penalty for an early repayment, which maintains the lender’s yield.

Exit Strategy

By definition, bridge loans are temporary and are of relatively short duration. So they require an exit strategy that pays off the loan balance and associated costs. Among exit plans, include selling the property. A conventional mortgage loan in a sufficient amount may be secured. Parts of the property may be sold, with the proceeds used to reduce the bridge loan’s principal balance, with the remainder then refinanced conventionally. Funds from other sources may be used to pay down the loan principal on an accelerated basis, like lot or condo sales. Or a combination of the above may be employed to ensure that the bridge loan is repaid within the agreed upon term.

Bridge lending and borrowing is not for the faint hearted. There is unusual pressure; a significant although calculated gamble; and often significant up-front costs involved. It is a serious business for both parties. But when the variables come together to permit a bridge loan to close, both the lender and borrower can realize substantial financial gains that could not have been achieved in the conventional loan marketplace.


 


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