When is a Commercial Real Estate Bridge Loan, a Bridge Too Far?
In Commercial Real Estate Bridge Lending, a business plan needs to be properly vetted and achievable. The business plan and experience of the Borrower are just as important as proceeds and interest rate of the loan. It is the symbiotic mix of these key loan attributes that determines whether a bridge loan is appropriate for a transaction. Due to the relative higher cost and shorter duration of commercial real estate bridge loans, the debt (and therefore uses of the capitalized project) must be accretive to value creation in the property. Collateral value must not only be increased by the amount of money invested, but significantly more so, to justify the time, effort, energy, materials, and dollars spent; and more importantly, to earn a return.
Bridge loans are a great tool. They provide a mutually beneficial scenario for the borrower and the lender. Lenders are attracted to providing this type of financing due to the higher coupon rate earned on their money invested, origination fee(s), shorter duration (allowing them to recycle capital faster and mitigating it being locked up in an asset long term, subject to adverse market conditions) and to a degree, the leverage point which provides some protection of their principal. Borrowers on the other hand, appreciate bridge loans for the level of proceeds they typically provide in a transaction and often less paperwork, time and effort to obtain the proceeds. It preserves more liquidity for the Borrower to invest in other activities rather than having capital tied to a single transaction.
One of the most lucrative areas in commercial real estate is the value-add sector, where real estate operators purchase assets that are performing below their potential and could be substantially improved by re-positioning the asset with monetary investment. Often times real estate operators implement a business plan with a three-to-five-year horizon in order to garner the highest Internal Rate of Return (IRR). Upon undertaking such a project, real estate operators must decide how they intend on capitalizing the project, that is how they intend to pay for it, and then create a business plan & budget outlining how necessary renovations/upgrades will be funded - often through a combination of debt and equity. In order to boost IRR, debt is placed on the transaction, significantly decreasing the personal dollars invested to get a project completed. It should be noted that the terms of the debt are extremely important in determining potential returns, and that inappropriate implementation of debt could adversely affect the outcome of the project.
Too often when a value-add business plan is not properly executed, Borrowers can be drawn to the idea of obtaining a subsequent short-term bridge loan to retire an initial short-term loan that was meant to stabilize the property (whether that be acquisition, construction, or bridge financing). The intention behind the second short-term loan is to successfully complete the planned scope of work, however this approach could easily fulfill the adage “throwing good money after bad”. The transaction needs to be reviewed with caution before proceeding since the proposed funding would be the second attempt at executing a potentially flawed business plan. Infusing additional capital may not remedy the situation if there is a fundamental flaw in the asset, strategy or market. However, there are circumstances for which a “second” bridge loan may be appropriate and advantageous. For instance, the market area of a property may have experienced significant changes since the initial business plan was created and implemented. In order to adapt and deliver a property with a highest and best use, subsequent bridge financing to implement such a change may be appropriate. Another scenario where subsequent bridge funding may be appropriate is due to partnership disputes or changes that would require an owner to “buy out” their partner. This would have nothing to do with the business plan, rather a remedy of the ownership structure that would require recapitalization of the project.
Bridge loans should not be looked at as an opportunity to receive funds to bail-out a borrower or to rescue a distressed or failed property. They are a financial instrument used to create value and increase investor yield. Commercial real estate debt has many forms, each with its own place based on a transaction’s structure, market and borrower. One should always fully think through a potential value-add project and consult with experts in the field to best position themselves for success and verify that the debt they are obtaining (likely bridge debt) will help them achieve their goals.
District is a balance sheet lender re-engineering the commercial real estate mortgage process. By developing innovative technology, District is able to increase the speed and accuracy of deploying capital while increasing transparency into the lending process. As a national firm, we specialize in short- to mid-term bridge debt on all product types with competitive rates and leverage.
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