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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   September 2008

Diversify to Stay Prepared

Bridge loans and mezzanine financing can be life preservers in today’s market

Commercial mortgage brokers are in an excellent position to benefit from the downturn in real estate. While it appears that the market has contracted and opportunities have stagnated, creative mortgage professionals can position themselves in the new marketplace.

It’s important to remember that clients still have financial needs. Brokers should expand their professional services by offering flexible solutions to the problem that never goes away -- the need for additional financing.

Commercial mortgages may not be as readily available as they previously were, but there are a variety of short-term solutions available to help with clients’ cash-flow issues. Bridge loans and mezzanine financing are often useful in real estate transactions, especially with most banks’ current reluctance to expose themselves to risky situations.

Bridge financing

Bridge loans are used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash. A good example of this occurs when cash flow from the sale of an asset is expected after the cash outlay for the purchase of another asset.

For example, when selling property, the owner may not receive the cash for 90 days but has already purchased a new property and must pay for it in 30 days. Bridge financing covers the 60-day gap in cash flows.

Bridge loans are often used for commercial real estate purchases to close on a property quickly, to retrieve real estate from foreclosure or to take advantage of a short-term opportunity to secure long-term financing. The need for this type of financing may stem from timing issues that arise from project phases with different cash needs and risk profiles that affect the outcome as much as the ability to secure funding.

These loans are usually paid back when the property is sold or refinanced, the borrower’s creditworthiness improves, the property is improved or completed, or there is another change that allows for permanent financing.

Bridge loans also are used in conjunction with traditional commercial mortgages. A developer may wish to carry a project while seeking permit approval. There is no guarantee the project will happen, so this bridge loan would probably come with a high interest rate from a specialized lending source that will accept the risk.

When the project becomes fully entitled, it is eligible for larger amounts, longer terms and lower interest rates from more-conventional sources. This is when a construction loan would be obtained to take out the bridge loan and fund the project’s completion.

Most banks do not offer real estate bridge loans because the speculative nature, risk, lack of full documentation and other factors do not fit their lending criteria. Bridge loans are therefore more likely to come from private funding sources such as individuals, investment pools and businesses that make a practice of providing these higher-interest loans.

Mezzanine financing

Mezzanine financing can be structured either as debt (typically an unsecured and subordinated note) or preferred stock. This type of financing is a subordinated debt or preferred equity instrument that represents a claim on a company’s assets that is senior to the claims of a company’s common shareholders.

Developers often use mezzanine loans to secure supplementary financing for development projects. This usually occurs in situations where the primary mortgage or construction loan-equity requirements exceed 10 percent. These loans are often collateralized by the stock of the development company, rather than the developed property itself.

These lenders can engage in a more rapid seizure of underlying collateral in the event of default and foreclosure, thereby mitigating their risk to some degree. Standard foreclosure proceedings can take more than a year, but stock is a personal asset of the borrower and legal seizures can occur in just a few months.

When to consider them

The difficulty in acquiring commercial loans in today’s market can cause a significant decrease in available working capital for numerous types of borrowers, resulting in cash shortages for immediate business expenses. Brokers need a variety of options to meet clients’ cash demands.

For example, consider a client who needs to acquire additional equipment after acquiring additional business. The client is cash-poor because of lending restrictions, but a creative broker can offer the option of leasing that equipment with no upfront cash outlays. Equipment leasing has solved the problem, despite lending cutbacks.

In a similar fashion, a wise broker also could offer the option of an unsecured line of credit for clients’ business to help them meet their needs for cash availability.

But the creativity doesn’t have to stop there. Other short-term solutions include debt and/or equity financing and even merchant cash advances for emergency funds.

•  •  •

Bridge- and mezzanine-loan products may sound complicated, but these financial products have already been packaged by specialty financing firms.

In many cases, companies that were previously in the mortgage industry expanded into these product areas and are seeking to partner with commercial mortgage professionals. They offer complete product suites, training programs, processing services, and Web-based facilities for loan tracking and accounting.

Applications often require only a minimal amount of paperwork, though higher amounts will require personal and business taxes and financials. If mortgage brokers choose to work with a financing firm, they usually must only forward the required information by fax or e-mail to their affiliate. Then that company processes the request.

Many commercial mortgage professionals can benefit from offering flexible financial solutions to their clients. These activities can generate residual income for years to come while bolstering income against the real estate downturn. This way, you’ll be prepared for success regardless of what happens in the marketplace.  


 


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