During the last few years, as competition has risen for prime commercial real estate, a number of investors have turned to distressed properties as an alternative.
Their goal is to buy the property, renovate or reposition it, and stabilize and improve its financial performance, so it can then reap income from new tenants and rentals or from a sale. The problem is that for investors that do not have enough capital to purchase properties outright, distressed real estate may not qualify for long-term financing from a traditional financial institution.
Enter bridge loans, which provide investors with capital to quickly purchase a distressed property. With a bridge loan, an investor can rehabilitate the commercial property, reposition it in its market, find new tenants, improve the balance sheet, and then refinance with a more traditional loan. The bridge loan, as the name suggests, spans the gap until borrowers can find long-term financing.
Bridge Loan Differences
Before seeking financing, investors should be aware of some of the common features of a bridge loan. Among them are:
- Shorter Terms. In general, bridge loans have a short lifespan. They routinely last for one year, though some may extend to three years or more while others may cover just a few months.
- Higher Rates. Because terms are shorter and risk is higher, interest rates on bridge loans are considerably higher than with traditional financing.
- Collateral Required. The real estate being acquired typically serves as collateral for the loan. And the amounts offered will be based upon traditional requirements (credit scores, business plans, revenues and profits) and forward-looking estimates of the property’s value once the rehabilitation or repositioning has been completed.
Challenges for Investors
Bridge loans may also pose challenges for investors. For instance, a bridge loan may come with sizable fees. Origination fees can run as high as 6 percent. Exit fees (also known as deferred origination fees) may be charged when the loan is paid off – often escalating over the life of a loan to encourage early repayment. And if the loan is extended beyond the initial term, the lender may assess an extension fee.
The timeline for securing bridge loans is relatively fast, often just a few weeks. Nonetheless, they come with a significant number of documents for investors to wade through. Failing to understand a loan’s provisions can result in unwelcome surprises later on. Investors may learn their bridge loan includes personal guarantee obligations, putting their personal assets in jeopardy in the event of a default. And certain provisions might allow the lender to seek recourse against a guarantor over a missed payment or a lapsed LLC or corporate registration.
Another potential pitfall is borrowing money from a lender who is betting against the borrower’s success. Such a lender may use aggressive loan terms to trigger default, and then acquire and resell the property at a substantial profit.
A Strategic Approach
To help address these challenges, investors should do their homework about a potential lender, discuss the lender’s willingness to alter unfavorable contract provisions, and carefully review all of the documentation associated with the loan. Counsel with commercial real estate and bridge loan experience should be engaged to review terms and negotiate with the lender.
Bridge loans can be an important financing tool. But they should be part of a disciplined overall acquisition strategy, one where the investor has a clear view of its debt obligations stabilizes, and associated risk exposures the timelines for renovating or repositioning a property, and the length of time it will take before the property appreciates in value.
To learn more about how we can assist commercial real estate investors through the bridge financing process, contact us for a consultation.