The number of commercial bridge lenders has grown substantially over the past several years, a trend that has made it easier and more affordable to find financing for transitional commercial properties. Many alternative lenders also have entered the bridge lending space, boosting the amount of available capital, lowering pricing and expanding the financing options for each deal. The entry of these new players, however, also has increased the risk for commercial mortgage brokers and their clients.
Bridge loans from the best alternative lenders provide speed, flexibility and certainty of execution, but not every lender can provide all of these. Brokers and their borrowers need to be diligent and thorough in selecting an alternative lender. Your choice matters in terms of the quality of service, timeliness of funding and flexibility of terms. If a lender has questionable financial stability, it could lead to a string of broken promises and result in a failed deal.
An expanding field
Generally, bridge loans offer short-term financing from anywhere between a few months up to five years. The loans are typically backed by commercial real estate that the borrower already owns or is looking to purchase.
Borrowers often use short-term commercial real estate loans to “bridge” a funding gap until they can arrange long-term financing or sell the asset. They may use the loan proceeds to upgrade the property, attract a new tenant, convert the property to an alternative use or take advantage of potential transactions in which speed and reliability are critical.
The bridge loan space has evolved as it has grown. More borrowers are using longer-term bridge financing to restore or improve properties, thus increasing their value. Property owners may need to carry the loans for longer stretches to give them enough time to stabilize the properties. Previously, bridge loans were mainly used for property acquisitions.
Banks and regional hard money lenders have acted as traditional financing providers in the bridge loan space. Other financiers of bridge loans include life insurance companies and pension funds; government agencies; real estate investment trusts; and, more recently, lending platforms that use the collateralized loan obligation (CLO) market as their primary execution channel.
Large hedge funds and private equity companies such as Starwood Property Trust and the Blackstone Group, as well as a slew of alternative nonbank lenders, have joined the business in recent years. Collectively, they’ve enlarged the space today to at least 236 bridge lenders, according to an internal survey conducted by Money360.
Competitive terms and prices
Alternative bridge lenders have several advantages over traditional lenders, starting with speed. Banks can take up to three times as long as an alternative bridge lender to process and approve an application and extend credit. Approval processes through alternative lenders can take between two and six weeks. A speedy turnaround matters to a borrower closing on a sale or buying out a partner.
Alternative lenders also typically have more freedom to structure a loan in terms of pricing, leverage levels and flexibility. Strictly regulated banks and other traditional lenders often have inflexible internal policies that produce rigid guidelines. Additionally, bank loans are secured by the real estate in question and usually must be personally guaranteed by the borrower. With most bridge loans, however, alternative lenders typically only use the underlying real estate as security. Many borrowers don’t want to have the liability of a personal guarantee on their balance sheet. This can be the decisive factor in choosing a nonbank alternative lender over a bank or other traditional lender.
The entry of so many alternative lenders also has lowered prices for bridge loans. Recently, the money pouring into the bridge loan space has boosted market efficiency and competition, and has forced down pricing for all transaction types. The price is typically calculated by a spread over the 30-day London Interbank Offered Rate, or LIBOR.
Leverage levels for bridge loans have remained stable at around a 75 percent to 80 percent loan-to-value (LTV) ratio for core assets in primary markets backed by good sponsors, such as office buildings in Los Angeles. Borrowers and mortgage brokers, however, should expect wider spreads and more conservative LTVs for transactions in smaller markets, those with less-experienced sponsors or for assets that are considered unconventional.
As competition in the bridge loan space intensifies, some alternative lenders are trying to separate themselves from the competition by taking on more risk, such as providing bridge loans for construction financing or so the owner can lease up the building. Some alternative lenders are structuring loans in ways that others may not. Many also are very competitive from a rate standpoint, offering prices closer to those of banks.
Gauge lending partners
More competition, however, brings more risks. In some cases, a new alternative lender could be little more than a platform focused entirely on a CLO execution — the vehicle used to securitize bridge loans — and may not have full discretion in the decisionmaking process or the funding of a transaction.
Lenders that are new to the bridge loan space may not know the market well. Many of these lenders may have been involved in the commercial real estate market in other capacities, such as placing equity, mezzanine financing or commercial mortgage-backed securities debt.
Given the risks, you will need to perform the necessary due diligence on bridge lenders. Talk to other borrowers or intermediaries who have done business with a prospective lender. This can help you assess the lender’s dependability, and determine whether they have the experience and funding capacity in the bridge loan space, as well as whether they have worked through several lending cycles.
You can take steps to gauge a lender’s overall viability and funding model by understanding their approval process and sources of funding. The lender may not be able to close on the loan if its source of funds dries up. You also should take a close look at a lender’s track record to ensure the lender can make its own credit decisions and isn’t required to consult a warehouse loan provider or potential B-piece conduit buyers to get approval to fund the loan.
Ultimately, a lender should offer the pricing that meets the need; the structure that meets the request; the authority to render a credit decision; and experienced staff to process and close the loan. An expanded bridge loan market means ample choices and capital for borrowers. There also is risk. With so many available options, you should take the necessary steps to ensure you’re partnering with the right lender.