Are Commercial Bridge Loans Worth the Risk?
Mar 23, 2017
Despite a volatile 2016 for many markets, many experts argue that the U.S. real estate market actually had a pretty solid year. After all, home prices appreciated further than the expectation and commercial mortgage rates remained low, despite the increase in the prime rate in December.
The acquisition and refinance of commercial and residential properties has remained affordable, and though 2017’s commercial interest rate forecast is still hazy, many commercial lenders are tightening their lending qualifications. Given the risk, is taking out a bridge loan a good solution?
The answer to that question: It depends. There’s no clear cut way to approach the matter. To appropriately answer that question, a borrower has to consider their financing goals and circumstances concerning their need for commercial real estate financing.
Let's take a look at a two-part example.
A Scenario for Traditional Lenders
A developer is looking to purchase a vacant shopping center that has seen better days. The property is a pocket listing and will likely not be on the market long because of its location and the price at which it is offered. Upon performing a quick analysis, the developer concludes that a healthy return on investment can be gained after the property is purchased, renovated, repositioned, and re-sold.
The developer has only a percentage of the property value available in cash, and needs to maintain her liquidity to cover the immediate costs that will present themselves after closing. In order to raise the money needed to purchase the shopping center, the developer would have to apply for line of credit against one or a few of her existing properties or do an outright refinance and cash-out.
It makes complete sense for the person to be investigating commercial real estate loans through traditional commercial lenders. There are two primary situations that may cause the developer to opt for a bridge loan.
A Scenario for Bridge Loans: Short Timeline
In this scenario, the seller is eager to sell the shopping center quickly, which presents a challenge for the developer. The application and underwriting would take a few weeks, at soonest, to get the financing from a conventional lender.
After reanalyzing her financial assessment of the property’s potential and reviewing her timeline to rehab the property, the developer concludes that obtaining a short-term bridge loan from a private company that can close quickly is an acceptable option. Even though the cost of borrowing using a bridge loan is higher than a loan from a conventional lender, the developer finds that she would still have an attractive return of investment by purchasing the shopping center in this way.
A Scenario for Bridge Loans: Lack of Supporting Financials
In this scenario, the developer unfortunately does not have good credit, or the financials required by the bank, both of which are needed to take on the risk of a commercial loan.
After reviewing her plans for the property and her financial situation, the developer decides that she is comfortable obtaining a short-term bridge loan from a private company who will base the loan total on the value of a hard asset instead. While credit and supporting financials are used by traditional lenders, she is confident with her choice to use a property as collateral to purchase the shopping center, given her assessment of the opportunity.
When is a Bridge Loan the Right Choice?
In this two-part scenario, the risks of taking a bridge loan would be worth the potential reward for the developer/borrower. And once again, that’s likely the biggest lesson: It depends on the scenario.
Financing through traditional lenders is a great fit for many borrowers, and comes with its fair share of advantages over commercial bridge loans – short term bridge loans do have higher loan fees and higher interest rates associated with the cost of borrowing. Bridge loans can benefit borrowers in search of alternative financing for commercial real estate, whether it be due to credit or due to a tight timeline.
However, if a borrower can utilize a bridge loan to achieve their goal, then the added risk of taking on a higher cost of borrowing should be considered a viable option. If your situation seems like it might be best suited for a bridge loan, we’re here to help.