Whether it’s a purchase loan that falls through at the last minute, a pre-foreclosure or a prime business opportunity that’s time-sensitive, there are borrowers who sometimes need bridge financing in a hurry.
A bridge loan can close in as little as three weeks or less. For some brokers, there’s a perception that this quick sprint to the finish line means an easy payday. That’s not reality.
In fact, quick-close bridge loan requests are among the most difficult commercial real estate loans to get funded, and they take a surprising amount of effort to complete. Imagine condensing a month or more of work on a deal into only a few short days.
Not every lender offers quick-close options, and those who do often expect the broker to do the heavy lifting — or at least carry some of the load. Brokers helping to facilitate a quick-close bridge loan must know the nuances of this helpful, but sometimes com- plex process that can solve imminent funding problems when handled correctly.
Committed borrowers
A major misconception about quick-close bridge loans is that fast money is relatively cheap. There is an inverse relationship between the speed of funding and the cost of that financing. The shorter the loan term, the more the costs are frontloaded. The more risk the lender is taking upfront by streamlining the underwriting process, the more expensive that money is going to be.
“A major misconception about quick-close bridge loans is that fast money is relatively cheap. There is an inverse relationship between the speed of funding and the cost of that financing.”
Those costs often are outweighed by the benefits of the financing — what the borrower can earn by having the cash. Because bridge financing is short term, a borrower with a viable exit plan can purchase an ideal property, complete construction or rehab of the site — or perhaps use cash out to fund other aspects of the business — and still come out ahead.
What is important, though, is that borrowers know this going in. They need to be committed and responsive. If the lender senses that the borrower is still shopping the loan despite impending deadlines, they may lose motivation to move quickly on approval. Likewise, if the borrower drags their feet evaluating the loan offer or handing over documents, those delays may blow up the deal.
In one instance, an extraordinarily motivated borrower needed to draw a portion of funds while the loan was in underwriting to bid at auction on a lucrative business asset. It was a Herculean effort, but he was able to obtain the funds in 48 hours.
Multiple considerations
There are many factors to consider when prequalifying a bridge loan request to determine if a quick close is on the table. High loan-to-value ratios (LTV) — a popular mortgage calculation made by dividing the loan amount by the appraised value of the property or asset — and quick closes are like oil and water. For a quick close, most borrowers will need a maximum LTV of 50% to 60%. A lender also will want a strong personal financial statement, especially if it is a full-recourse loan.
Realistic property valuations are key. In a best-case scenario, the borrower will have a recent appraisal — no more than 90 days old. It may be possible to assign that appraisal, which saves valuable time. In the absence of an appraisal, look for nearby comparables, ideally properties within walking distance. A broker price opinion — the estimated value of a property as determined by a real estate broker — can sometimes be utilized to determine value, saving both time and money.
In the event the actual property valuation turns out to be too low, the borrower may be able to offer cross-collateralization with other properties that have sufficient equity. For example, a borrower needs a very quick close due to an impending foreclosure sale. A lender had agreed to fund the loan with a second-position lien on another property owned by the borrower.
However, it is discovered in underwriting that a bank already had a second lien on the other property, killing the deal. It is possible to salvage the deal by refinancing all the borrower’s properties combined, paying off all mortgages and reducing the combined LTV to an acceptable level.
Supporting documents
With leased properties, the most competitive borrowers will have a current rent roll that highlights the quality of tenants and the longevity of the leases. New, short-term leases are less appealing.
If it is an owner-occupied commercial property, the borrower will need to show that the business is profitable and that it can comfortably cover debt service. The borrower should be prepared to show recent tax returns and year-to-date income statements which are substantiated by corresponding bank deposits.
Run a simple debt-service coverage ratio calculation: multiply the loan amount requested by the anticipated interest rate to determine if there’s enough profit in the business or net income from the leases to comfortably make loan payments. If not, is there enough room in the loan request to incorporate an interest reserve?
Planned exits
As the loan request moves toward closing, underwriters will need to review corporate documents such as articles of organization, operating agreements and certificates of good standing. These need to be up-to-date and immediately available. Also, the IRS will have issued a letter assigning an Employer Identification Number (EIN) to the business. That letter is required to verify the business ID number. If it is not available, a quick closing may be jeopardized.
A clear exit plan for paying off the loan is crucial. If it is unclear how the bridge loan will be paid off or if it is subject to unknown variables that cannot be clearly solved, the lender will be hesitant to fund.
For bridge loans that will transition to long-term debt, bridge lenders will perform an “exit stress test”, wherein they run the numbers ahead of time to determine if the loan is fundable at the end of the bridge term with a long-term lender. If the loan will not qualify at exit, bridge funding can be threatened. Savvy brokers will run their own stress tests before submitting the bridge loan request.
A title insurance policy is required on each closing. Quick-close loans leave little time to resolve title issues that may pop up. So, no title insurance means no funding.
Title partner
A preliminary title search is available as soon as the deal comes in. Reviewing that can flag potential problems — liens that have been paid off but not removed, a different owner listed, different property address — so those issues can be resolved prior to closing. The best way to avoid title problems, though, is to pick the right title partner.
“It all comes down to eliminating as many variables as possible,” according to title insurance expert Christine Gilmore, vice president of sales with Chicago Title. She points to three significant differences to watch for when choosing title companies.
First, many local title companies are brokers for direct insurers. As such, these agencies must follow no-exception requirements that can tie up a loan closing, whereas going directly to the insurer allows for more flexibility. Another important distinction is the specific title company’s claims loss reserves. This represents what the insurer can stand to lose should an issue arise after closing. Some companies are too lean when it comes to paying claims to take any chances with a deal that is nonconforming.
Finally, choosing the right title company comes down to the tenacity of the title representative who is getting the deal closed. “Where there’s no preexisting relationship, there’s less incentive for the title representative to work through the deal,” Gilmore said. “If the deal doesn’t fund, no one is getting paid.”
In one example, a borrower needed a quick-close bridge loan to pay off a maturing construction loan and complete work on the project. He picked the same local title company that had handled his land purchase. However, just days before the scheduled closing, that company declined to insure the deal without a temporary occupancy certificate. That process would have taken weeks to complete. This was a broker title company that was not able to make any exceptions. The deal was dead. However, by switching the title work over to a national direct insurer, the loan request was revived, and it closed within the two-week deadline.
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Bridge loans can close quickly to meet a borrower’s needs. These loans can be especially challenging, however. A borrower who is responsive and informed can help keep quick deals on track. A broker can facilitate the streamlined process by prequalifying the loan request based on factors that include realistic property valuation, low LTV, strong borrower net worth and a viable exit plan. Brokers also play a role by staying in the loop, anticipating document requests and paving the way for smooth title work.
