Commercial real estate financing can overwhelm new investors. In particular, the multiple types of financing can seem downright daunting. For instance, bridge loans offer investors a flexible source of short-term financing. But, what is a bridge loan? In this article, we’ll provide an overview of bridge loans for multifamily properties.
Specifically, we’ll discuss the following topics:
- What is a Bridge Loan?
- Bridge Loans for Multifamily Properties
- Final Thoughts
What is a Bridge Loan?
Overview
Bridge loans serve as a short-term financing tool until investors can secure permanent financing (i.e. a long-term mortgage). While individual terms vary, bridge loans in commercial real estate typically have terms from three months up to three years. And, unlike more permanent financing sources – which can take a long time to close – you can close on a bridge loan far more quickly.
Advantages
This final point covers the primary advantage to bridge loans: speed. When a real estate investor applies for a permanent mortgage on a multifamily property, the closing period could last as long as 90 days (or more). On the other hand, borrowers can secure bridge loans in as short a time as two weeks. For a time-sensitive deal, this speed can prove crucial to success.
Furthermore, when reviewing permanent mortgage applications, lenders impose strict requirements on borrowers and the associated properties. For instance, before closing, most lenders will require that a property meet a certain stabilized lease-up threshold – often as high as 95%. With a bridge loan, you can avoid these requirements, closing on a deal quickly – regardless of current occupancy – and using the funds to put the property into service.
Disadvantages
However, with speed and flexibility come some inherent drawbacks to bridge loans – namely, cost. In return for the above advantages, bridge loans charge higher interest rates than permanent mortgages. Depending on the deal and individual borrower, a bridge loan may have rates anywhere from 3% to 10% above market rates for permanent ones. Additionally, these loans often include high closing fees – another cost to consider in a multifamily underwriting model.
Bridge loans can be an outstanding financing tool, but real estate investors should weigh these pros and cons before applying for one.
Bridge Loans for Multifamily Properties
Multifamily property developers and investors require bridge loans in a variety of situations. While not an all-inclusive list, here are three common examples to consider:
Example 1: Bridge Loans to Acquire Properties in Time-Sensitive Deals
As stated, bridge loans generally close far more quickly than permanent mortgage applications. With time-sensitive deals, this speed can be a tremendous asset.
For example, say a broker lists a $5,000,000 apartment building in a competitive market. You’re confident in your ability to raise at least 30% of that as a down-payment for a permanent mortgage, but it will take some time. You may need to sell a couple properties in your portfolio, or you may need to pitch the deal to a variety of investors. Regardless of reason, a bridge loan could give you the flexibility to A) quickly purchase this property, while B) raising the capital necessary to secure permanent financing.
Example 2: Bridge Loans for Value-Add Multifamily Deals
Many investors use a value-add commercial real estate strategy. With this approach, you purchase a property, renovate/improve the units and common areas, and increase the rents. Due to the income-based valuation approach in commercial real estate, these increased rents and net operating income then lead to an increase in property value.
Unfortunately, some lenders will approve a mortgage to acquire a stabilized multifamily but not renovate it. For instance, say you secure permanent financing to purchase a fully leased apartment building. Analyzing the rent roll, you determine that, with an additional $500,000 you can renovate each unit over a two-year period, which will lead to a 20% increase in rents.
Rather than pay that $500,000 in cash, you can secure a two-year bridge loan to finance the value-add improvements. Then, once complete, you can have the property appraised and refinance your permanent mortgage based on the increased value, paying off your bridge loan in the process.
Example 3: Bridge Loan to Cover Delayed Capital Contributions
Many multifamily deals include some sort of delayed capital contribution. For instance, an investor may agree to contribute money – but only after the property has completed a cost audit. This is a common situation in historic tax credit (HTC) deals.
With federal HTC deals, developers can secure federal tax credits up to 20% of the qualified rehabilitation expenses, or QREs. So, a $5,000,000 renovation could potentially lead to $1,000,000 in credits, which an investor may acquire for 80 cents on the dollar – $800,000 (NOTE: HTC investors cannot technically “buy” these credits, and the transfer rate fluctuates with the market).
But, prior to making the full capital contribution, this same investor may want to confirm that the developer can, in fact, complete the renovation process and have it approved by the National Park Service, which administers the federal HTC program. This approval includes a QRE cost audit by a CPA firm. Accordingly, a developer may not see this $800,000 for over a year (or more), that is, through the development, construction, and cost audit periods.
As a result, many HTC developers turn to bridge loans. In this example, a bridge loan could cover all or a portion of the $800,000 federal HTC investor’s contribution until actually made.
Final Thoughts
Bridge loans, as with all commercial real estate financing sources, have their own unique pros and cons. In the right situation, they can serve as outstanding tools for making a deal happen. But, before securing one, investors should weigh the speed and flexibility against the increased costs.
If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate investment opportunities.