Without exception, the need for funds is a frequent requirement for Investors and developers of property. At various stages of the development, investors and developers need funds to manage the requirements. It may become necessary to quickly raise funds from sources and options other than typical hard money lending options.
For instance, a project may be nearing completion, and it may be necessary to source funds as quickly as possible to complete the project. This is just one of the many scenarios for the requirement of urgent funds. Among the various available options, one of the most suitable options in cash-strapped scenarios is the commercial bridge loan.
More and more Commercial Real Estate and individual investors/developers are turning to commercial bridge loans to meet urgent needs. Despite the timely nature of the loans, its suitability for meeting urgent demands, and its increasing popularity, eligibility, and loan rates are often misunderstood. Here is all that you need to know about commercial bridge loans.
What is A Commercial Bridge Loan?
Commercial bridge loans are short term financing options intended to meet specific requirements in the shortest possible time. Also known as bridge financing and gap financing, commercial bridge loans are typically used to meet an emerging requirement or take advantage of a business opportunity by making a timely investment.
Investment is all about timing, and investors who make a quick decision on a chance often make a great CRE property deal. However, the decision making needs to be followed up by investing the right amount of funds into the venture at the right time.
The term commercial bridge loan, like other bridge loans, is self-explanatory. It bridges the gap between an urgent need and a proper solution. It is a stop-gap arrangement that is never intended to be the sole means of financing. It is intended to be used as an interim measure till alternate financing options are available.
Bridge loans are regarded as relatively fast in terms of disbursal, which helps to meet the demand without losing time. Meanwhile, the investor or developer looks for long-term financing options that will take over the bridge loans before the end of the term.
This way, the needs are met, albeit at a slightly higher interest rate, while the long-term solution kicks in at a later stage. Despite the relatively higher rate of interest, bridge loans are extremely useful and, by virtue of being a short term option, do not significantly hit profits.
Main differences between a bridge loan and other loans?
There are four different main differences between a bridge loan and other loans, as listed below:
Bridge loans are short term financing options and are only meant to bridge the gap, as a stop-gap arrangement until a regular financing option works.
The waiting period is considerably lower in bridge loans when compared with any other loan. This makes it suitable for meeting urgent requirements that can differentiate the property or the investment.
The interest rates and the fees of bridge loans are relatively higher than that of other long-term financing options. Typically, the difference in interest rates between a bridge loan and other financing options could go up to 2% on an average.
The terms of repayment/qualifying criteria are different. As mentioned above, bridge loans are short term financing options, and the amortization is interest only, with a complete repayment made before the end of the tenure.
Have more questions? Read frequently asked questions about bridge loans
Availing a bridge loan is easier than securing a long-term financing option. This is not just in terms of the waiting period, but the criteria for qualifying for a loan. This is precisely why the interest rates are higher as lenders take on a higher risk level when extending credit to the borrower. Another positive aspect of a bridge loan is prepayment penalties. Unlike other long-term financing options, where the borrower ends up paying costs when foreclosing a loan, in the case of bridge loans, prepayment penalties do not apply.
The process – how commercial bridge loans work?
With the overview of commercial bridge loans and the important differences highlighted, it is time to look at how the process works. The actual scenario and process may differ slightly depending on the requirement; however, the overall process is more or less the same as explained herein.
A commercial bridge loan is availed when an investor or developer finds a business opportunity that appears promising. As per the investor or developer’s calculations and assessment, the expectations of monetizing the property in a specific window may be high.
Consequently, the developer or investor may find the need to quickly source liquidity to find the project. Similarly, the investor may be expecting funds from some other source within a particular period and may need funds to exploit a different opportunity. The bridge loan helps to meet the requirement until the funds flow in.
Collateral is typically made available for availing of the commercial bridge loan. In addition to the collateral value that is put up, lenders make an assessment on the actual amount that can be extended as a bridge loan.
This is on the basis of various criteria, such as the loan to value ratio, or the value of the property after it has been renovated. In most cases, the loan amount that is extended is generally anywhere between a maximum of 70 to 80 percent of the assessed property value.
The investor or developer uses this loan amount to meet the requirements, and in most cases, this solves the problem until the long term option works out. Commercial bridge loans involve origination fees and other fees, including appraisal fees. This is necessary for the loan to be processed and could be more than the processing fees involved in other long term loans.
Salient features of commercial bridge loans
Commercial bridge loans belong to the category of fast-to-fund loans. In other words, commercial bridge loans are extended faster, in a shorter period of time, dispensing with the need for long waiting periods.
Commercial bridge loans attract a heavier rate of interest when compared with regular long term financing options. This is attributed to various factors – the higher risk levels involved in extending credit, the change in qualifying criteria, and the disbursal speed of funds.
Commercial bridge loans are typically issued by banks, lenders, and financial entities that offer financial services and loans to businesses. It is important to add that hard money lenders and private lenders belong to this category.
Commercial bridge loans are extended based on collateral offered by the borrower. Typically, the multifamily property for which the loan is being availed serves as the collateral for the bridge loan. However, this is not mandatory, and any other property may also be considered as collateral for a bridge loan.
Depending on the lender, the collateral’s value may have a bearing on the qualifying criteria of the borrower for the bridge loan.
The tenure of commercial bridge loans is relatively shorter – anywhere between a few months to a year – during this period, the investor or developer either expects to receive long-term funding options or monetize the asset.
Scenarios when Commercial Bridge Loans are suitable
Commercial Bridge Loans are suitable for various typical scenarios. Bridge loans are not suitable as a long term option, but only as a short term option in the below-mentioned scenarios.
#1 To quickly fund Commercial Real Estate Investments
Investors in commercial real estate often find the need for urgent funds to take a stake in properties. In the absence of liquidity, investors end up losing good opportunities. Commercial bridge loans are purpose-oriented loans that specifically meet this requirement for urgent liquidity.
Prime properties are often up for grabs, and investors rue the lack of access to funds to take advantage of good opportunities. With commercial bridge loans, investors get access to funds quickly, helping in making a quick decision to buy the asset.
After achieving the first goal of acquisition, investors can then look for long term financing options if the property is intended to be held for a long period. In the vent that the property is intended to be monetized quickly by improving or reselling, investors can then use the sale proceeds to clear the bridge loans.
#2 Funds for renovation/extensions and value addition
The value of CRE properties increases significantly when suitable renovations, facelift, or extensions are made. This accommodates the requirements of prospective tenants or buyers. Modifications to properties help in monetizing assets better, either through rentals or by outright sale. Investors or developers may find a cash crunch in meeting this requirement, without which the property may not fetch the desired value.
With commercial real estate bridge loans, investors and developers can quickly improve or extend the property and receive better value. The bridge loans can be settled either from the proceeds of the sale or from long term financing on completion of the modifications. Long term financing is linked to the value of the property and its income generation capability.
With improvements, a property’s value increases manifold and fetches better terms in long term finance. This can then be used to clear off the short-term bridge loans and hold a prime property stake.
#3 Funds for urgent procurements
There are certain atypical scenarios when a business is in need of urgent funds for procurement. This could be for expanding inventory, or this could be for the purpose of partaking in a sale of products and inventory items that a business typically requires. For instance, a business dealing in certain products may come across a liquidation sale of components or accessories that are part of the products.
The sale deal may be attractive and could present a unique business opportunity to quickly reap profits and achieve long-term objectives. However, the lack of funds may be the stumbling block in this ambitious plan and opportunity. With commercial bridge loans, a business can take advantage of this opportunity and procure the products.
Post-procurement, the business can look for long term financing and use the stock. This stop-gap arrangement works when the inventory that is being procured has proportionate value. For instance, the procured products’ value should fetch profits that cover the bridge loan interest rates.
#4 Funds for moving shop or opening a new division
Businesses may require to move from one location to another due to one of many reasons. This requires access to funds urgently. Business loans typically involve a waiting period, which could jeopardize business plans in expanding or relocating to a new location.
With commercial bridge loans, it is possible to quickly decide on a new location and invest in setting up a presence in the new location. Under setting up shop in the new location, a business can then secure long-term loans to exit the bridge loans.
This permits the business to focus on the core business activity, rather than spend time and efforts on sourcing liquidity. This is also useful for a business that is in expansion mode and need of funds. With commercial bridge loans, it is possible to meet the stop-gap arrangement requirements and then secure long-term financing options.
#5 Overcoming limitations as a result of poor credit score
Businesses may sometimes have a poor credit score as a result of unfavorable circumstances. Consequently, a business may not get a long term business loan to meet its needs. However, the business may have the potential to turnaround good revenues with a little boosting investment. The inability to raise funds may hurt the prospects of the business.
With a bridge loan, the business can work towards earning strong revenues, which will help it secure long-term financing based on improved showing. This will help the business to move to the next level, despite having a poor credit score. Ultimately, the business will also end up improving the credit score as a result of the long term financing and repayment.
#6 Bridge loans for acquisitions till investors take stake later
Bridge loans are also used as a stop-gap arrangement to fund acquisitions, till the time investors take a stake later. Most investors have holdings in various properties or business interests/assets and are generally not in a position to immediately release funds for taking a stake.
However, the investors may have planned to take a stake later after releasing funds from a stake sale or by diluting holdings in an asset that is not performing as good as the new opportunity. A business may then require an interim financing option like mezzanine financing to bridge this gap.
This way, the business will be able to conclude the acquisition and receive funding from a regular investor at a later date. The business can exit the bridge loan with investors’ investments and work towards reaching business objectives.
What should a prospective borrower (commercial entity) look for in a bridge loan?
Common to all assessments of loans, a business needs to typically look at aspects such as the interest rates, the maximum amount extended as a loan, the various fees associated with the loan, and the repayment terms. These are more like boilerplate assessments and common to all loans. In the case of bridge loans, the borrower needs to also look at additional criteria to get the best offer from a lender. Here is a look at some of the key aspects that a borrower needs to consider when seeking a bridge loan.
The time required for sanctioning funds –
This has got to be the single most important criteria for assessment. A bridge loan is sought mainly for expedited access to funds. In other words, the speed with which funds are disbursed is the key differentiators of loans and bridge loans. It is, therefore, necessary to ensure that the lender offers the fastest disbursement timeline.
This will help meet the requirement as desired. Depending on the amount involved, and the relationship between the borrower and the lender, it is possible for loans to be disbursed in just one day or it could take as long as four weeks.
Prepayment/foreclosure terms –
Bridge loans, unlike business loans, do not come with the clause of foreclosure or prepayment charges. In other words, the borrower is not expected to make an additional payment due to repaying the loan amount earlier than agreed.
Since the amortization is interested only, the lender will prefer the loan amount to be repaid as agreed – at the end of the loan tenure. However, as the interest rates are higher and as bridge loans are solely used as an adhoc arrangement, borrowers typically choose to pay off the loan amount earlier. It is necessary to check if the lender includes other charges when the borrower repays earlier than agreed.
Common terms followed by Lenders
While the actual terms, conditions, limitations, and rates may differ as per use cases, here is a ballpark of the standards presently prevalent in commercial bridge loans.
The minimum and maximum loan amount extended as a commercial bridge loan could start from 1,000,000 USD and go right up to 50,000,000 USD. This differs from segment to segment and also depends on unique requirements and scenarios.
Value of loan in terms of percentage –
The loan in terms of percentage is typically around 80% of the Loan to Value and 85% of the Loan to Cost. This is generally the maximum value offered by lenders, as it offers the lender the option of safeguarding interests in the event of non-repayment. A lender who has financed a heavier percentage of value will end up losing money when the repayment defaults.
Interest rates –
On average, the interest rates of bridge loans are typically around 2% more than other loans’ interest rates. The interest rates of bridge loans are typically anywhere between 9 to 11 percent.
All commercial bridge loan amortization are interest-only modes, and the borrower agrees to repay the amount in full at the end of the tenure. Borrowers typically look for options to repay the loan amount prior to the end of tenure.
Bridge loans are extended based on collateral offered. This could be the property/asset that is intended to be acquired, or it could also be an existing asset. For instance, an investor who holds property and is interested in improving it may seek a bridge loan with the property as collateral. Similarly, the borrower can also treat the existing property as collateral for loans for a different property.
Tenure of commercial bridge loans –
While the tenure of commercial bridge loans may vary and depend on the lender, the average maximum tenure is between 9 and 12 months. Certain lenders are known to offer lengthier terms, and this depends on the circumstances surrounding the loan and the relation between the lender and the borrower.
Applicable fees –
The applicable fees for commercial bridge loans include appraisal fees, title fees, an origination fee of around 2% to 6%. There could be other fees involved – however, the fees, as mentioned above, are standard fees typically applicable to bridge loans.
Bridge loans are a practical method for raising funds to meet an urgent requirement as a stop-gap arrangement. However, bridge loans are suitable only for requirements that are short term in nature and are not suitable for use as a long term option. Business entities confident of raising funds before the end of the term will find bridge loans to be the perfect solution for raising liquidity in the shortest possible time.