Are Bridge Loans Good For Commercial Real Estate?
Are you curious about what role bridge loans play in the world of commercial real estate? Take a look at what you need to know.
Imagine that you’ve found the perfect office building to acquire, but won’t have the cash to close until your current property has sold. Or maybe your renovation project is taking longer than anticipated to complete, but your balloon loan is coming due in the next few weeks. In situations like these and others, commercial real estate investors and developers turn to bridge loan financing to raise cash fast. In this article we’ll discuss how bridge loans work and how bridge loans serve as an alternative form of financing for commercial real estate.
Defining Commercial Bridge Loans
As the name implies, a bridge loan ‘bridges’ or ‘fills the gap’ between a short-term loan used for work such as new construction or redevelopment and more permanent long-term financing. In some markets 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 be used to 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
May be issued by banks, private lenders, and alternative lenders such as debt funds
The Difference Between Bridge Loans and Traditional Loans
Some of the key differences between bridge loans for commercial real estate and traditional loans include:
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.
Qualifying for a real estate bridge loan can also be easier 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 the faster loan funding and easier qualification of a bridge loan is that the fees and interest rates are more expensive compared to a traditional loan. Closing costs and fees 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 bridge loan is used in part because of the shorter loan term.
Unlike a traditional commercial lender, bridge loan lenders normally want the loan to be paid off quickly. A commercial real estate bridge loan does not have a 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 Commercial Bridge Loans Work
Commercial bridge loans are structured by the lender to meet the specific needs of each borrower. Financing fees and interest rates for a bridge loan are normally greater than with a traditional loan, but funding is faster and the loan terms and conditions are more flexible.
The loan-to-value (LTV) of a commercial bridge loan is between 65% and 80% of the property’s appraised value. If a building is being renovated, the lender will use loan-to-cost (LTC) which takes into consideration capitalized capital expenditures.
Common 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 acquire 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 will qualify for a traditional loan.
Things to Look for in a Commercial Bridge Loan
There are two things to look for in a commercial real estate bridge loan:
1. Funding timeframe
While traditional lenders are normally slow to fund, the funding timeframe for a commercial real estate bridge loan can be a few weeks or less. Investors who need to fund quickly to acquire a property or jump-start a repositioning project may find a bridge loan the ideal short-term solution.
A good bridge loan for commercial real estate will offer the borrower the option to increase the loan balance during the loan term for the purpose of paying 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 proceeds when and if needed. This helps to reduce and keep interest payments to a minimum.
Pros and Cons of Commercial Bridge Loans
While there are advantages to a bridge loan for commercial real estate there are also some potential drawbacks to be aware of as well:
Pros of a commercial bridge loan
Offer immediate funding to acquire a property or satisfy an existing obligation.
Faster funding time frame makes a commercial bridge loan an ideal solution when time is of the essence.
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.
Cons of a commercial bridge loan
Property being borrowed against must be used as collateral for a commercial bridge loan, putting the entire investment at risk in the event of a
Other property of the borrower used as collateral may also be at risk if payment on a bridge loan is not made on time, though unsecured bridge loans are available for the right borrower.
Higher fees, both up front and upon repayment, can create cash crunches for the borrower.
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.