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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2013

Offering Safe Passage for Distressed Deals

Bridge financing can help investors turn around troubled assets

Offering Safe Passage for Distressed Deals

This year easily could be called the year of the bridge loan. Encouraged by still-low interest rates, investors increasingly have sought bridge financing for deals in the distressed-property market. Their goal typically has been to turn these properties around into performing assets and eventually reach a point where they can be financed through conventional sources.

In addition, as lenders have returned eagerly to the origination space, the refreshed capital in the market has caused many bank and nonbank lenders to look for higher returns on loans. Today, new bridge lenders are popping up with increasingly aggressive terms, offering borrowers and commercial mortgage brokers opportunities to finance projects that until recently were considered unfundable.

Bridge loans have their pros and cons, however. Commercial mortgage brokers who decide to take distressed deals across their route to reach stabilization should know the requirements of bridge lenders, as well as the costs involved in bridge financing. By educating their clients on these issues, brokers can help clients bridge the divide between nonperforming and performing assets.

Bridge financing offers many business opportunities for commercial mortgage brokers and borrowers alike. In particular, brokers can expand their reach to borrowers by helping them execute on distressed-property opportunities and maximize their return. It is important, however, that brokers garner a thorough knowledge of the ins and outs of this type of financing to be able to guide clients in the right direction. Here are some of the basics of bridge lending.

The basics

As its name suggests, bridge financing is intended to bridge a currently underperforming property into a performing property. For example, some bridge lenders offer money to rehab a project substantially. Other lenders may look to finance properties that have a good cash flow but are missing a tenant.

A bridge loan is not a bailout loan for a troubled borrower. It normally is offered to a buyer of commercial real estate, or to cash-out on a recent all-cash purchase. With that in mind, commercial mortgage brokers should determine which clients could be potential bridge-loan borrowers.

Bridge borrowers are typically opportunistic investors who want to reposition a property and have experience doing so. Many bridge borrowers buy properties from banks or distressed owners, and have the wherewithal to change the direction of an asset, but they need capital to do so. Some bridge borrowers own property-management companies or are general contractors.

Few lenders will offer financing to bridge-loan seekers who don’t have the experience required to turn around and reposition the asset. Lenders typically are aware that this task carries inherent risk and requires the skill to turn an underperforming property into a performing one. They look for borrowers who have experience in the market in which they are seeking bridge financing, as well as with the property type they are looking to finance and with the overall size and scope of the project. In addition, bridge borrowers should have good credit and solid liquidity.

Lenders

There are many players in the bridge-financing arena. Brokers can seek funding for their deals from banks, nonbank lenders, life companies, delegated underwriting and servicing lenders, and other institutional lenders.

This year’s relatively low rates have caused even conservative lenders to look for yield with bridge financing. Some lenders offer lower rates for bridge loans so that they can keep a good borrower’s business for the permanent loan take-out after the repositioning period is over.

Terms

Bridge loans typically run for two-year or three-year terms with interest-only payments. Bridge loans have a shorter prepayment penalty so that the borrowers can refinance into conventional loans as soon as possible.

Many bridge loans include a 1 percent or 2 percent origination fee, and some also include a 1 percent exit fee. Because of the short duration of bridge loans, the origination fee is a way to get investors the desired yield on their loans. The payments for the bridge loan can be included in the loan and will be called an interest reserve, which allows borrowers to avoid making out-of-pocket payments on properties that don’t have cash flow yet. Lenders may sweep any of the property’s current cash flow toward the bridge payments to alleviate the borrower’s cost of paying interest over the payment interest.

Leverage

There are three ways to determine leverage in bridge financing: stabilized loan to value (LTV); loan to cost (LTC); and as-is LTV. Lenders may look to cap the loan amount on the lesser of the stabilized LTV (a maximum percentage of the appraised value at stabilization) or the LTC (a maximum percentage of the total project cost, inclusive of the purchase price plus interest reserve, rehab costs and closing costs). Some lenders may further limit the borrower’s proceeds by capping the day-one draw at a set loan to as-is value.

For example, a lender that allows a maximum  65 percent loan to a $1,500,000 stabilized value  (65 percent of $1,500,000 = $975,000) or 80 percent loan to a $1,200,000 cost (80 percent of $1,200,000 = $960,000) will offer a loan of $960,000. The borrower then will bring in $240,000 (that is $1,200,000 less the $960,000 loan).

Many bridge lenders require borrowers to bring in all of their cash on day one. In the previous example, if the lender has a cap on day-one proceeds, such as 75 percent, and the value is $1,000,000, the day-one loan will be no greater than $750,000. In such cases, the lender will make sure that the total loan of $960,000, less the day-one draw maximum of $750,000, will result in $210,000 worth of funds being drawn by the borrower over the course of the loan for interest reserve and capital improvements — such as hard costs and soft costs, as well as any leasing commissions and potentially some good-news money, which is money back to the borrower in the event a lease is signed and additional value is created.

Submission

When it is time for commercial mortgage brokers to submit a bridge loan, the most critical component is to present the borrower’s plan for repositioning the property. This plan should address the big question: How will the new borrower manage to get the property stabilized when the previous owner could not?

In some cases, there may be improvements, which will require the borrower to provide a budget with a draw schedule. Some properties may need to be re-tenanted, which requires the borrower to explain how this can be accomplished. It is recommended that borrowers provide bridge lenders with information like the new property-management company, any new leases, data on the vacancy and absorption in the market, and anything else that supports the plans for the property. The more specific the borrower is about the plan execution, the more likely a bridge lender will buy into that plan’s success.

The strength of the borrower is paramount to the success of a bridge loan. Brokers should include the borrower’s résumé and a list of previous successful projects in the submission. The bridge-loan submission also should show the borrower’s financial strength and ability to support the project should anything go wrong and extra money is needed.

•  •  •

The availability of bridge financing — as well as the growing demand — is expected to continue through this coming year, with lending terms becoming more aggressive as new players enter the market. Commercial mortgage brokers can expect borrowers to seek higher leverage, more features and less stringent credit parameters.

Down the road when interest rates increase, expect capitalization rates to compress, rents to increase and the economy to continue to stabilize. As a result, there will be less of a need for bridge financing. Until then, brokers can help borrowers enjoy the current opportunity to borrow relatively low-cost funds while capitalizing on real estate purchases with significant potential.  


 


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