We are in an era where value addition is the catchword, becoming a defining concept. In virtually every facet of business and life, the need is for increased value, which is the differentiator in a world where everything appears common. Unsurprisingly, this trend has also spread into the world of investing.
Market conditions are in a state of flux, and the best option available to investors is to look for opportunities where value is added to property acquisition. The intended outcomes of acquisition are to make decent profits, it is necessary to look at the best investment options that facilitate value addition.
For long, bridge loans have received unfavorable assessments and have been considered an option with limited use. This is attributed to the terms of bridge loans and how bridge loans were traditionally used.
Commercial real estate is all about making the most of capital, funds, the right choice of property, and the sale timing. In an increasingly challenging environment, investors are finding it challenging to work on projects with expected outcomes due to a combination of circumstances.
In the midst of this, bridge loans have emerged as the dark horse, the unlikely option that is now serving as one of the best options for investors to add value. Here is a look at how bridge loans have come to be accepted as a good option, in addition to showcasing the possibilities.
Change in perception about bridge loans
There is a clear change in the perception of investment stakeholders about bridge loans. Once considered a reserve option, used only in times of specific needs, bridge loans have become one of the most useful options available to investors. By virtue of being tagged as hard money loans, bridge loans were and still continue to be rated as an expensive option. Additionally, investors viewed bridge loans as volatile due to changing rates.
A combination of circumstances has now made it challenging for commercial real estate investors to find the right funding options to meet requirements for transforming properties into profitable investments. For instance, the rise in prices is not evenly matched by the amount offered as a loan.
Additionally, lenders do not finance a higher percentage of the property’s total value, which results in a shortfall of funding required. This effectively impacts the investor’s ability to make necessary modifications or improvements to make the property a right choice for buyers.
Crunching the numbers to understand the advantage of bridge loans
Bridge loans are great options for investors who typically raise funds through equity partnerships. Equity partnerships are a prudent decision as it permits the investor to have a stake in multiple properties, thereby spreading out the investment. This helps bring in better profit margins, as well as balancing underperforming assets.
For instance, a project may not fetch the desired results, and this may affect earnings. However, when the investor has a stake in multiple projects, the profits from a good investment will help overcome the less than expected earnings from an underperforming asset. Without foreknowledge or identification of properties that may underperform or perform exceedingly well, it is essential to spread out investments wisely.
Bridge loans help investors similarly meet the shortfall of funding. With about 85% of the total project cost being financed, it is a viable option for investors to rely on bridge loans to manage properties. The icing on the cake is the interest rates that are marginally higher than the rates of regular financing options. In certain instances, it is possible to get a rate that is similar to typical financing options.
For instance, while theoretically, lenders can finance 75% of the project costs, it is not the case always. An investor who receives permanent funding of 75% is an exception, as very few lenders offer to fund to the extent of three-fourths of the property value.
A financed property through regular financing routes will most likely end up with funding around 50% of the property value. Consequently, the investor would have to shell out funds from other sources to meet the shortfall. However, the most important consideration here is that investors would have to manage the costs towards improving the property from their funds.
It would have been either improvement with own funds or no improvement. Either of the two choices is not in the best interests of the investor. A property that does not have the right kind of facelift, or improvements or extensions, will not fetch the market’s right value.
Consequently, the investor loses a great opportunity to make a better margin. Similarly, using out of pocket funds for improvements will impact the investor’s ability to put funds elsewhere. A good property may be available for quick closure, and the lack of liquidity availability will affect the investors’ ability to take a stake.
A bridge loan covering a higher percentage of the property value frees up the investor’s funds and provides adequate capital for completing improvements. Commercial real estate is all about having access to liquidity for handling a project right from the beginning. This will give the investor the advantage of quickly completing a project, closing a deal, reaping the profits, and moving on to the next deal.
Acquiring a controlling stake with lesser investments
The single biggest advantage of a bridge loan is the ability to acquire a controlling stake in a property with as little investment as possible. This option gives the investor the luxury of looking at multiple options simultaneously. For instance, a property that can be financed with 85% of the total value will require a relatively smaller upfront investment and investor commitment.
This will give the investor the luxury of getting the maximum advantage from the property quickly. Bridge loans are typically short term in nature, and an investor who has assessed property to be a profitable venture in a short period can use the loan to realize the goal.
Investors also have the option of refinancing the property before the end of the bridge loans and using the funds for quick acquisition of additional property. The eventual sale proceeds can then be used for closing the loans and pocketing the profits. This reduces the need for higher investment on the part of the investor.
A bridge loan is not a silver bullet for all scenarios.
A bridge loan is a good and viable option. However, it is not a silver bullet or a strategy that can be useful as a strategy for investors across all scenarios. It is suitable only for investors who wish to hold properties for a short period and move on to the next. It is also suitable only for investors who are ready to take the plunge with floating rates of interest. Investors who are comfortable with fixed rates of interest will not find bridge loans suitable due to floating rates, which are known to rise as per market conditions. Investors who prefer to lock in the interest rates and protect themselves from fluctuations will not find a bridge to be a good option.
Bridge loans are certainly effective and useful for investors with a certain outlook and mindset, especially when it comes to properties that are identified as valuable with faster appreciation in a short period. However, investors who are looking at a long hold will look at other traditional options for funding the property. It is more a question of selecting a funding option on a case by case basis.