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Bridge Loans For Commercial Real Estate: How Do They Work?

Integrity Financial Groups, Inc. > Financial Education > Bridge Loans For Commercial Real Estate: How Do They Work?
Bridge Loans For Commercial Real Estate

Bridge Loans For Commercial Real Estate

What role do bridge loans play in commercial real estate? Suppose you’ve found the perfect office building to acquire but don’t have the cash to close on the office until your current property has sold. Or maybe your renovation project is taking longer than anticipated, and your balloon loan is due in the next few weeks. Equity is usually the option when your credit profile does not fit into the conventional credit box of traditional lenders.

Commercial real estate investors and developers use bridge loan financing to raise cash quickly. Bridge loans serve as an alternative form of funding for commercial real estate.

A bridge loan bridges or fills the gap between a short-term loan for work, such as new construction or redevelopment, and more permanent long-term financing. Bridge loans are also known as interim financing, gap financing, or swing loans.

A bridge loan allows the borrower to pull cash out of the property to pay off an existing loan or settle other debt obligations. Bridge loans can also help a commercial real estate investor cover part of the cost of acquiring a new property and entice the seller with a quick close of escrow.

Commercial Real Estate Bridge Loans:

  • Are short-term, usually between three months up to three years
  • Have relatively high-interest rates and fees
  • Usually are fast to fund
  • Backed by collateral such as real estate
  • It may be issued by banks, private lenders, and alternative lenders such as debt funds

Understanding Bridge Loans For Commercial Real Estate

The Difference Between Bridge Loans and Traditional Loans

Some of the critical differences between bridge loans for commercial real estate and traditional loans include the following:

Closing time frame:
Waiting for a traditional loan to be underwritten and processed can cost valuable time and create missed opportunities. By contrast, the closing time frame for a bridge loan can be three weeks or less. A commercial real estate bridge loan allows an investor to move quickly when time is of the essence, then arrange permanent financing after the bridge loan closes.

Loan qualification:

Qualifying for a real estate bridge loan can also be more accessible than being approved for a longer-term loan. While bridge loan lenders may have credit score minimums, they will also consider loan qualification factors such as debt-to-income ratio (DTI), the borrower’s track record and other assets, and the viability of the investor’s business plan, and future refinancing and payback plans.

Fees and interest:

The tradeoff for faster loan funding and easier qualification of a bridge loan is that the fees and interest rates are more expensive than a traditional loan. Closing costs and expenses associated with commercial bridge loans typically include appraisal and escrow fees, title policy costs, and administration and loan origination fees. Interest rates vary based on the borrower, lender, and specific loan terms but generally range above the prime rate for a traditional loan.

Use of loan:

A bridge loan lender is more willing to dig deeper into a borrower’s plan to acquire, upgrade, or reposition a property and evaluate the investor’s track record of success for similar projects. On the other hand, a traditional lender prefers to finance the property after the renovation is done and the building is leased up. Commercial real estate bridge loan lenders are willing to be more flexible with how the loan is used partly because of the shorter loan term.

Prepayment penalty:

Unlike a traditional commercial lender, bridge loan lenders usually want the loan paid off quickly. A commercial real estate bridge loan has no prepayment penalty, with payback periods generally ranging from three months to one year or more. Real estate investors can benefit by paying off a bridge loan early without incurring fees or other penalties.

Understanding How Bridge Loans For Commercial Real Estate Work

The lender structures commercial bridge loans to meet the specific needs of each borrower. Financing fees and interest rates for a bridge loan are usually more significant than a traditional loan, but funding is faster, and the loan terms and conditions are more flexible.

A commercial bridge loan loan-to-value (LTV) is between 65% and 80% of the property’s appraised value. If a building is in the process of being renovated, the lender will use loan-to-cost (LTC), which considers capitalized capital expenditures.

Standard bridge loan scenarios:
Take advantage of an immediate opportunity to acquire a property, then refinance with a more affordable long-term traditional commercial real estate loan. Use a commercial real estate bridge loan to receive a new property before the current one is sold, such as a business needing to expand or downsize. Make improvements to attract tenants willing to pay higher rents and increase long-term gross rental income to make qualifying for a commercial bank loan easier. Stabilize an office building so that the long-term cash flow and debt obligations qualify for a traditional loan.

There are two things to look for in a commercial real estate bridge loan:

1. Funding timeframe
While traditional lenders are generally slow to fund, the funding timeframe for a commercial real estate bridge loan can be a few weeks or less. Investors who need to invest quickly to acquire a property or jump-start a repositioning project may find a bridge loan the ideal short-term solution.

2. Facilities
A good bridge loan for commercial real estate will allow the borrower to increase the loan balance during the loan term to pay for capital improvements, tenant improvements, or leasing commissions. The advantage from a borrower’s perspective is that, unlike traditional loans, which fund all the proceeds in an up-front lump sum, borrowers can draw down on additional profits when and if needed. This helps to reduce and keep interest payments to a minimum.

A commercial bridge loan offers immediate funding to acquire a property or satisfy an existing obligation. When time is of the essence, a commercial bridge loan provides a faster funding time frame and makes an ideal solution. Bridge loan lenders are more willing to think outside of the box, with less focus on a borrower’s credit score and more attention paid to the viability of the acquisition or renovation project. At some point, every commercial real estate investor needs to think about borrowing money. While traditional long-term loans are the go-to source for capital, they aren’t always the best commercial real estate loan choice. Short-term bridge loans are an alternative source of funding that commercial real estate investors and developers use to raise capital quickly, with loan terms customized for the specific needs of the borrower and the lender.

What to Know about Bridge Loans For Commercial Real Estate

A bridge loan differs from conventional construction loans because bridge loans are asset-based. They also have higher interest rates, shorter terms, and easier access. While banks typically source construction loans, a bridge loan usually comes from private money investment funds and private lenders. Private bridge lenders can generally provide highly customized loans rapidly—something that most traditional lenders cannot offer. As the name implies, they are intended to provide bridge capital to get a borrower from one source of financing to another.

Bridge loans usually have higher interest rates than traditional commercial loans. The rates are generally 50 to 200 basis points higher than you might expect with a conventional bank loan, with the actual rate depending on the specifics of the deal. Highly levered or otherwise higher-risk sales will generally have higher interest rates and vice versa. Time is money—and a bridge loan can help a borrower move forward faster than if they were to try to line up traditional financing. Short-term bridge loans are one of the easiest and most secure ways of financing short-term projects. Some bridge loans can be closed and fully funded in a month or less compared to a traditional lender, where loans generally take at least 45 to 60 days to complete. The fast processing time of bridge loans is a significant advantage of this type of financing. 

Bridge loans are highly flexible and, therefore, are a great source of financing when someone has an unconventional deal. This might include purchasing and renovating a sober living facility or senior living center. These properties are generally challenging to finance and are scrutinized by traditional lenders. Conventional lenders have more restrictive loan terms that usually require loan committee approval; bridge lenders can be nimbler and provide tours customized to the deal in question. A typical real estate investment strategy is to buy a Class B or C property and then execute a value-add strategy that improves the property to Class A or B quality.

Value-add strategies require some combination of physical and operational improvements that help stabilize the property. Repositioning such efforts is ideal for value-add investors whose business plan anticipates future solid cash flows and increased property value. Unlike conventional lenders who prefer to finance stabilized properties, bridge lenders are usually more comfortable considering the risk of lending on a deal based on future cash flows (something that can be projected but never guaranteed). 

You need a non-recourse loan. There are two types of loans: recourse and non-recourse. Recourse loans require that a borrower put up sufficient collateral to make the lender whole in the event of default. This could include a borrower’s other investments, retirement accounts, cash reserves, etc. Non-recourse loans, conversely, limit the borrower’s liability to the commercial property being financed. Most borrowers prefer non-recourse loans as there is no burden of repaying the loan using other assets unrelated to this deal.

You have poor credit. Short-term bridge loans are excellent solutions for sponsors with credit scores that do not meet the thresholds of a conventional lender. While a bank or agency lender (e.g., Fannie Mae or Freddie Mac) might not approve a loan for this reason, a bridge lender is usually more willing to work with someone regardless of their credit score or credit history. A bridge lender’s underwriting process leans heavily on the value of the asset and less on the borrower’s credit profile.

Real World Bridge Loan Scenarios

Example 1: Buying an underperforming multifamily building.
Let’s say you want to buy a 150-unit apartment building running at a 70% occupancy rate. The asking price is $20 million. You believe that the property has been mismanaged and that making roughly $5,000 worth of cosmetic improvements to each unit will stabilize the property and generate significantly more cash flow. You believe these improvements will cost less than $1 million all-in and, in turn, will make the property worth closer to $30 million. A traditional lender might not be willing to loan the property given its in-place cash flow, especially if you (the borrower) do not have a proven track record in the value-add investment space. This is where a bridge loan might make sense.

In this case, a bridge loan can be an attractive option. A commercial bridge loan worth $21 million would be enough to cover the acquisition and the improvements. You anticipate it taking 8-12 months to finish the renovation, at which point you would refinance the property. At a 75% loan-to-value ratio, you could get a traditional loan for $22.5 million, which would be enough to pay off the $21 million bridge loan while still generating a profit.

As you can see here, another benefit to the borrower is that they will not have their equity at stake. The bridge loan will fully fund the acquisition and renovations. Upon refinancing, the borrower will walk away with roughly $1.25 million in profit and will then have 25% equity in the deal upon stabilization.

Real World Bridge Loan Scenarios

Example 2: Renovating a hotel property during a global pandemic.
Here’s an example that we’re personally familiar with. Two multifamily investors decided to purchase a small, 30-key hotel in February 2020. They were securing a traditional bank loan to buy and improve the property, but the lender pulled back when the global travel industry virtually shut down in March 2020. Given state mandates to shelter in place, the lender became wary of the deal and was concerned that the investors would have trouble executing their business plan given their lack of experience in the hospitality industry.

Instead, the borrowers turned to a bridge loan to complete their financing needs. The traditional lender still offered a 60% loan-to-value mortgage (down from the originally proposed 80%). Then the borrowers used a bridge loan to finance the balance of the acquisition cost plus the anticipated renovation costs.

The bridge lender was drawn to the deal in this scenario for a few reasons. First, the investors planned to use the pandemic-induced shutdown to complete the renovations with record speed. Rather than renovating one or two rooms at a time, they were able to shut the hotel down and renovate all at once. This allowed the hotel to reopen faster and to essential workers working at the nearby naval base. Moreover, the bridge lender could offer the borrowers a six-month interest-only period to help them through the shutdown and renovations—with the option for a second six-month IO period if travel restrictions had not been lifted.

The borrowers have since renovated the hotel and are booking out, anticipating a solid spring and summer season. The borrowers expect to refinance the property and repay the bridge loan in full later this year. Had the bridge loan not been an option, the deal would have virtually fallen apart just as it was about to close.


Is A Bridge Loan For Commercial Real Estate Right For You?

Any commercial real estate investor will want to weigh the pros and cons of bridge loans carefully. While bridge loans are an excellent source of capital under certain circumstances, they do not come without their risks. We noted their higher-than-market interest rates, but they also tend to charge steep fees for late payments. They also assume that more permanent financing will be available upon stabilizing the property, which is usually but not always the case—it depends on the deal specifics. A bridge loan might not be best for you if you are not highly confident in your business plan and exit strategy. You must be able to execute on time and within budget.

That said, bridge loans are attractive for most borrowers needing short-term capital. As you’ve seen here, they can be used for various situations. They are handy for experienced value-add investors with a clear path forward in improving and repositioning their property.

As always, borrowers should consider all of their financing alternatives before deciding. When in doubt, consult us, and we will Structure the correct Financing products for your project.

Bridge loans for commercial real estate are one of many tools under the structured finance umbrella that gives our clients various structuring options when financing a large project or development, typically for borrowers with highly specified needs that a simple loan or another conventional financial instrument will not satisfy. In most cases, structured finance involves one or several discretionary transactions to be completed; as a result, evolved and often risky instruments must be implemented. Integrity Financial Groups has positioned itself as something exclusive and in demand in the financial industry. We offer premium products to Structure higher value for your project and developments. 

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    About the author

    Dallin Hawkins brings over two decades of expertise within the finance sector, holding executive positions and distinguished as a top performer since 2003. Throughout his tenure, he has orchestrated and structured in excess of $60 billion in volume across diverse industries, including renewable energy, construction, transportation, manufacturing, mining, drilling, and oil and gas sectors. His adept negotiation skills and profound industry acumen have facilitated the successful management and funding of numerous intricate transactions. Leveraging foundational financing principles, Dallin consistently engineers structured and holistic funding solutions. His proficiency spans financial structuring, information technology, marketing, networking, and sales, underpinning his capacity to navigate multifaceted challenges with finesse. Moreover, Dallin's leadership extends beyond transactions, having personally mentored and overseen the development of countless sales executives. His guidance encompasses deal negotiation strategies, adept management of client expectations, and effective time management techniques tailored to the nuances of the finance domain. Notably, Dallin's recent financial venture stands poised to redefine and fortify the financial landscape through unparalleled growth trajectories.

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