Bridge loans are, by definition, unconventional. The deals associated with this type of financing often involve unusual circumstances, short terms and tight closing deadlines. And yet, the most conventional of commercial real estate lenders — banks — can be the primary source of funds for a bridge loan.
Although banks won’t finance every kind of bridge deal, it is well worth knowing whether a private lender is funding a loan using bank financing. When these worlds collide, borrowers tend to get a better rate and a longer term on bridge loans sourced primarily from banks.
Private bridge lenders have been around for decades. Private lenders fill a void during economic downturns when banks tend to significantly curtail their lending. Even when the economy is booming, a percentage of borrowers will need short-term loans from private lenders because banks and other conventional lenders typically won’t do certain types of loans.
Some borrowers also simply prefer the flexibility and speed of bridge financing. They may qualify for a lower-rate conventional loan, but they need a faster turnaround time to ensure they don’t lose the deal to another investor.
Aside from banks, several classes of investors supply the funds for bridge loans. The money can come from private lenders, family wealth offices and other funds established to allow its share-holders to invest in secured debt. These private sources of financing are more expensive both in real terms and in opportunity costs.
Unlike banks, private bridge lenders can’t fund their loans through branch deposits or by lower-cost borrowing alternatives, such as the Federal Home Loan Bank. So, the investor financing the loan has a higher opportunity cost than a bank. That private investor will tend to want the capital back more quickly, so he or she can rapidly deploy their money into other investments. This is one of the reasons why bridge lenders seek out banks as a funding source.
Borrower benefits
Banks have produced real benefits for borrowers needing bridge loans. For one, banks have expanded the capital base for lenders that make short-term loans. This has brought additional lenders into the space, making the loans more readily available. Bank financing also allows some room for a private lender to lower their rates and attract borrowers.
Private bridge lenders seek bank funding for several reasons, but one primary reason is to make use of the power of leverage to increase the return and to fund more deals. To make a $1 million loan, for example, the lender might use $250,000 of its own capital and borrow the rest from a bank. If the lender is charging a 10% rate to a borrower, but is primarily funding the loan with bank money at a 7% rate, it can significantly increase its return, as well as free up its remaining capital to do other deals. The bridge lending market is fiercely competitive, however, so lenders that use bank financing often pass on some of their savings to the end borrowers in the form of lower interest rates.
One other undeniable benefit of bank capital is the longer maturities. Nonbank bridge loans typically have maturity dates of one year or less. The private lender wants its capital back quickly. Much of their profit is imbedded in upfront fees, so they want to churn their limited pool of funds from project to project as quickly as possible. When banks are their funding sources, however, a longer horizon usually flows through to the end borrower. The private lender’s bank, for example, may be comfortable with a 36-month maturity. Lenders also are offering automatic extensions, provided that performance benchmarks are met, with the end borrowers benefiting from the extra time.
Banks must have the entrepreneurial mindset to grasp deals quickly, as well as the necessary infrastructure to ensure certainty to close.
Defining the relationship
Banks also are attractive to private bridge lenders because banks don’t become equity partners in the deal. They have no ownership interest in the bridge lender as a condition of funding the loan. This enables private lenders to limit partnerships and better manage the expectations of those involved. This is particularly beneficial in circumstances where the various investors differ in terms of their financial capacity, investment timeline, management strategies or tax consequences.
Aside from banks, several classes of investors supply the funds for bridge loans. The money can come from private lenders, family wealth offices and other funds established to allow its share-holders to invest in secured debt. These private sources of financing are more expensive both in real terms and in opportunity costs.
Unlike banks, private bridge lenders can’t fund their loans through branch deposits or by lower-cost borrowing alternatives, such as the Federal Home Loan Bank. So, the investor financing the loan has a higher opportunity cost than a bank. That private investor will tend to want the capital back more quickly, so he or she can rapidly deploy their money into other investments. This is one of the reasons why bridge lenders seek out banks as a funding source.
Big vs. small banks
The challenge for private lenders is finding a bank that can move as quickly as they do. Banks must have the entrepreneurial mindset to grasp deals quickly, as well as the necessary infrastructure to ensure certainty to close. There are two kinds of banks that leverage loans: Larger banks provide big warehouse lines, while smaller banks provide smaller lines or leverage on a transactional basis.
The lines offered by large banks typically have the lowest rates. They usually have larger minimum loan-size standards, however, and large banks deal only with big, established lending groups, making them inaccessible to smaller private lenders. Also, the credit box governing larger lines is generally rigid. Smaller banks are often more expensive, but offer greater flexibility. A nonbank lender looking for a $20 million or $30 million line might have little success getting the attention of a large bank, but this size is ideal for a smaller, more nimble bank.
The lending environment has changed dramatically in the past 10 years. Bridge loans used to be called “hard money” and were viewed by banks as carrying an intolerable amount of risk. In reality, most bridge lending is simply another loan product, one requiring speed and flexibility that many banks will now fund indirectly through private lenders.
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Today’s bridge loans are legitimate financial products that serve the needs of a large segment of the commercial real estate market. Bank leverage ultimately gives mortgage brokers more choices and brings the borrower the benefits of greater access, lower costs and better terms.
