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Bridge Financing: How Does It Work?
Bridge financing is a loan option that is used to immediately finance a real estate purchase, renovation, or completion while longer-term funding is secured.
Image by Berenice Melis from Unsplash.
Easily one of the most flexible financing options available to commercial property investors, bridge loans are incredibly versatile short-term financing vehicles that can be deployed to serve a multitude of purposes. In most cases, when an investor needs funding to cover the gap between the moment they get approved for a loan and the actual funding of that loan, they use a bridge loan.
When utilized appropriately, commercial bridge loans can provide significant benefits for investors. Even so, amid the vast offering of financing vehicles for commercial investors to consider, these loans can sometimes remain a mystery to some of the less experienced borrowers.
So — for those who may want to know — how exactly does bridge financing work? Let’s start with the basics.
What Is a Bridge Loan?
A bridge loan is a unique type of short-term financing that often has a simple structure and fast turnaround times. Sometimes referred to as gap financing, these loans are named for the way they are utilized to “bridge the gap” between an investor’s immediate need for capital and a permanent financing solution. As such, they are often deployed to finance a commercial real estate investment when the timing of the acquisition or financing is a critical component of the deal’s success.
It can be noted that since the “bridge” portion of the moniker technically only describes the usage of the loan and not any specific characteristics, any type of loan could be utilized as bridge financing. That said — within the commercial real estate sector — bridge financing typically refers to those specific loan options which are used to immediately finance a real estate purchase, renovation, or completion while longer-term funding is secured.
Typical Attributes of Bridge Loans
As mentioned earlier, while any loan can be used in a bridge position, there are a few key attributes shared by most commercial bridge loans that make this type of financing unique. Some of these shared attributes include:
Shorter Loan Terms
Gap loans are not meant to be used as a permanent financing solution. As such, this type of financing typically comes with a term anywhere between three months to three years — with most landing in the 12- to 24-month repayment range.
Faster Funding
Bridge financing is meant to provide an immediate source of capital while permanent financing can be secured. Unlike most other commercial financing vehicles, bridge loans tend to have rapid turnaround times — both for closing the loan as well as the releasing of funds. The trade off, however, is that they usually also come with significantly higher interest rates.
Asset Focused
Also unlike most commercial mortgage loans that focus more on a borrower's creditworthiness, bridge loan eligibility usually depends more on the value of the target property rather than the financial strength of the borrower. This can be an extremely beneficial attribute for borrowers with credit or legal issues.
Obtaining a Bridge Loan
While requirements will vary depending on the lender, getting a bridge loan is not unlike obtaining any other kind of commercial financing. Most lenders will still require much of the same documentation (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — with the caveat that the financials of the target property are of higher importance than those of the borrower.
Even so, metrics such as debt service coverage ratio (DSCR) and loan-to-value (LTV) or loan-to-cost (LTC) still come into play, with some lenders even setting expectations for cash reserves and even borrower experience. The amount of funding a borrower is eligible to receive is mostly determined by a combination of various factors including property value, cash flow of the subject property, and the borrower’s net worth. The lender will typically loan between 65% and 80% of the LTC and 80% of the LTV of the finished value of the property.
Using Bridge Financing
The flexibility of bridge financing allows these loans to be used in a variety of scenarios. Remember that bridge financing is meant to be acquired quickly, and just as soon replaced by a more permanent financing solution. Among many other possible use cases, investors may consider using commercial bridge loans for situations like:
Making an immediate acquisition under strict time constraints.
Accessing immediate capital while permanent financing is secured.
Funding property rehabilitation to meet permanent financing eligibility requirements.
Obtaining funds to support lease-up activities.
Gaining access to capital while borrower creditworthiness is improved.
Acquiring funds to ensure the smooth operation of an asset while ownership interests are determined or while putting together a project team.
What is bridge financing and how does it work?
Bridge financing is a type of short-term financing that is used to “bridge the gap” between an investor’s immediate need for capital and a permanent financing solution. Bridge loans are typically deployed to finance a commercial real estate investment when the timing of the acquisition or financing is a critical component of the deal’s success.
Bridge financing can be used in a variety of scenarios, such as making an immediate acquisition under strict time constraints, accessing immediate capital while permanent financing is secured, funding property rehabilitation to meet permanent financing eligibility requirements, obtaining funds to support lease-up activities, gaining access to capital while borrower creditworthiness is improved, and acquiring funds to ensure the smooth operation of an asset while ownership interests are determined or while putting together a project team.
Bridge loans can also be used for repositioning a property in order to get more competitive permanent financing and — while not feasible as a permanent financing solution — are often leveraged to increase the profitability of an investment or improve cash flow.
What are the advantages of bridge financing?
Bridge financing offers several advantages to commercial real estate borrowers. These include flexibility in loan terms and fast funding.
Bridge financing is very flexible, both in its purposes and its loan terms. The length of the loan, monthly repayments, interest rates, and many other aspects are all open to negotiation with many lenders.
Bridge loans are also among the fastest-closing financing packages available to commercial real estate borrowers. A loan can close in a matter of days, which can enable an investor to execute their real estate strategy quickly and effectively.
What are the disadvantages of bridge financing?
Bridge loans have higher interest rates — often significantly higher than rates on longer-term financing. This means that monthly payments could get costly, even despite being interest only. Beyond that, bridge financing also may have fees of up to 2% of the loan amount. This isn't too out of the ordinary for a commercial mortgage, and this fee can often be negotiated.
Source: www.multifamily.loans/what-are-commercial-bridge-loansWhat types of properties are eligible for bridge financing?
Bridge loans generally depend on the value of the target property more than any other factor. Eligible properties include office, retail, industrial, multi-family, and hospitality. Bridge loans are typically used for short-term financing needs, such as acquisition, cash-out, or rate and term refinancing.
What are the qualifications for bridge financing?
The specific eligibility requirements for obtaining bridge financing typically vary depending on the lender, but getting a bridge loan is more or less the same as obtaining any other kind of commercial financing. Much of the same documentation is required (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — but in most cases, it is the financials of the target property that are of the highest importance to the lender.
Investors should also note that the amount of funding a borrower is eligible to receive is typically determined by a combination of factors including property value, cash flow of the subject property, and the borrower’s net worth. An investor should be able to provide the lender with this information.
While requirements will vary depending on the lender, getting a bridge loan is not unlike obtaining any other kind of commercial financing. Most lenders will still require much of the same documentation (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — with the caveat that the financials of the target property are of higher importance than those of the borrower.
Even so, metrics such as debt service coverage ratio (DSCR) and loan-to-value (LTV) or loan-to-cost (LTC) still come into play, with some lenders even setting expectations for cash reserves and even borrower experience. The amount of funding a borrower is eligible to receive is mostly determined by a combination of various factors including property value, cash flow of the subject property, and the borrower’s net worth. The lender will typically loan between 65% and 80% of the LTC and 80% of the LTV of the finished value of the property.
Bridge loans can also be used for repositioning a property in order to get more competitive permanent financing and — while not feasible as a permanent financing solution — are often leveraged to increase the profitability of an investment or improve cash flow.
Using Bridge Loans for Property “Flipping”
Gap financing is commonly used to acquire commercial properties at a substantial discount — typically when an asset is in poor condition or during adverse market conditions.
The way this works is that bridge lenders generally determine a value for the renovated property that incorporates both the purchase price as well as the assumed cost of the rehabilitation or renovation to be done. They then use this value as the investor’s borrowing limit. Though actual standards vary (at the lender’s discretion), bridge loans are usually offered to borrowers at 80% of the LTC value of the property as an industry standard.
Since gap loans have impressively fast closing and funding times, investors can pretty much begin any rehabilitation or renovation that needs to be done on the property at once. When the work is complete, the newly renovated property can then be sold at a significantly higher value than what it was acquired for. If this is done just right, this allows for not only the ability to pay back the bridge loan but also a decent profit on top of that.