The US economy is witnessing the sudden surge in the Commercial Real Estate Bridge lending for the last five years.
Along with other aspects, the substantial weightage given to the CRE lending since the U.S. economic recovery has led to the rise in demand for the Commercial Real Estate Bridge Loans.
The Commercial Real Estate Bridge Loans also known as the Commercial Mortgage Bridge Loans are the short-term loans for the commercial real estate.
But these cannot be said to be permanent ones and mature between 6 months to 24 months or to a maximum of 3 years. These are the flexible financing available to the borrowers for purchases, renovations and up gradations of the properties.
These are taken up when there is no option for permanent financing. In most cases, the Commercial Mortgage Bridge Loans are taken on the existing properties to renovate them and qualify for the permanent financing.
On the cover, these loans look very lucrative and beneficial to the investor. But there are cases of these going wrong.
A scrupulous scrutiny of the borrower and his real estate can help the investor in making decisions about lending the Commercial Mortgage Bridge Loans.
It is first required to understand the reasons for taking them.
When are the Commercial Real Estate Bridge Loans called for?
The Commercial Real Estate Bridge Loans are called for even by the high profile business organizations when they need urgent money to invest in the Commercial Real Estate before they qualify for the permanent financing.
The Commercial Mortgage Bridge Loans is also a handy financing tool when the borrower is looking to buy, renovate and sell off a commercial real estate be it an apartment or any other property.
Raw land is often the property that the borrower looks for these Commercial Real Estate Bridge Loans as they do not qualify for the long-term permanent finances.
- The occupancy rate in the property, mostly the hotels, inns or even apartments and commercial shopping complexes are unsatisfactory to qualify it for the permanent loans.
- The borrower’s credit profiles indicate defaults or need improvements to qualify for long-term financing.
- The urgency of capital is so much that the borrower cannot simply wait for procedures of permanent financing.
- The dispute in ownership or incomplete ownership may also not qualify the borrower for the permanent sources of financing.
- The borrower has made up his mind to sell the property, hence does not want to go for permanent financing.
- The borrower has bought the property because he is getting it at a very low price but cannot sell it in its current condition.
Why should the Commercial Real Estate Bridge Loans go wrong?
The Commercial Real Estate Bridge Loans are very attractive to investors having idle money and willing to part with it for short durations. The reasons for this are more than one.
Firstly, fixed returns of 6 percent to 10 percent per year are quite higher when compared to the meager returns of 1.77 percent from the junk bonds for the same duration.
Adding to the investors’ delight are the no fees and no loads deducted from the investor’s share. This will give him straight 6 percent returns.
Now the underlying question is – why do these Commercial Real Estate Bridge Loans earn so high returns?
Well, the answer to the question lies in the basic concept of the bridge loan or the lending. The investors here are actually temporarily funding the borrowers who cannot get the permanent financing.
“The basic idea is that you are making a temporary loan to someone who cannot get a loan from a typical financial institution for some reason or other, and is willing to pay a higher rate” says Terry Savage, a nationally syndicated personal finance columnist in Chicago and author of “The Savage Truth on Money,” indicating the risk involved in the lending.
This is the asset-backed funding rather than being the borrower’s credit profile backed loan. There it goes.
There is too much of risk involved here. And you are getting higher returns for the high risk involved in the investment.
Higher risks can give you failures in the investments leading to the Commercial Real Estate Bridge Loans going wrong.
What could go wrong in the Commercial Real Estate Bridge Loan?
So you know that there is risk involved in the Bridge loan. It is however absolutely fine to take the risk for the returns, provided you receive your share of returns on time. But the agony remains that all of this is not as simple and plain as it seems to be.
The actual scenario may change after the deal has been struck. Possible situations where things are not as per expectations:
Longer duration than that in the deal
The Commercial Mortgage Bridge Loan is not as liquid as one thinks it to be. The investor might be interested in investing his amount only for a definite period say for six to eighteen months for handsome returns.
But he might not be getting the repayments at the time of maturity of the loan. The borrower might not be able to do so and might be requesting for an extension.
This way the investor will have to stay invested in the loan for a longer duration much against his wishes.
Lack of proper evaluation of risk
Handsome returns promised on the deal might be just enough for some investors to put in their hard money. But a proper evaluation of the risk would have helped them in making wiser decisions. Since the loans are the only asset-backed loans, the risk increases.
However, the investor should also analyze the business of the borrower to check out the repayment capacities.
Now the restrictions of time and proper equipment for risk analysis also hamper proper evaluation of risk before the lending of the Commercial Mortgage Bridge Loan.
Lending more than committed
One of the situations that arise after the temporary finance has been sanctioned is that the borrower needs more money due to either his wrong calculations or because of things not working his way.
The Commercial Mortgage Bridge Loan is on the improved value of the property rather than on the ‘as – is’ value.
So any wrong calculation will lead to stopping of the renovation work. In such situations, it is obvious for him to look back at his financier for more lending.
Here the investor ends up lending more for fear of losing the already lent amount. This may bring in disharmony between the two parties.
Susceptible to defaults
The Commercial Mortgage Bridge Loan are susceptible to defaults as well. There could be many reasons for this. The lender might have done his part by lending the temporary finance.
But there could be situations where the borrower could not make out things as per his expectations and meets with failure.
Defaults in such cases are quite common. One of the familiar situations is the property not qualifying for the permanent financing. The borrower in such a situation might not be having enough money for the repayments.
Some amount of precautions on the part of the investors can limit their losses arising on account of Commercial Real Estate Bridge loan going wrong.
Measures to be adopted
The investor is ultimately lending his hard money to the borrower for the short term finance for the purchase or for the renovation of the property.
So it is in his interest to carry out certain precautionary measures to avoid the lending going wrong.
Transparency and disclosure
The two need to be adopted right from the very beginning. The lender should get involved in getting the updates of the project being financed by him through the temporary financing schemes.
The proper planning and the scheduling of the project should be studied at the inception itself. This will help the investor in learning where his hard money would be going to as the Commercial Mortgage Bridge Loan.
Focus on Returns
The entrepreneurs are not happy giving away this information to the lender. But the investor should still focus on the returns of the property bought or being renovated for sale or permanent financing.
The loan is backed by the asset. Still, some evaluation should be carried out to know why the borrower was denied a permanent financing.
The option exists in many of the Commercial Mortgage Bridge Loan. But the investor has to see that the collateral and the borrowers are meeting the performance criteria.
Commercial Real estate Bridge Loan is the bridge gap before the permanent financing of the property or the sale of the same. The high returns to the investor are justified by the risks undertaken in the lending. But some measures on his part can also help him in reducing down the defaults and losses to some extent due to the lending going wrong. Careful analysis and time were given to the project helps.