Bridge Lending Simplified

Bridge loans have been excellent financing tools during the past several years. Investors use them as short-term financing to complete the task of stabilizing under-performing properties. When properties are renovated and fully leased out bridge loans are paid off and usually replaced with permanent financing. They are used for purchase and refinance projects.

Generally a couple of main factors dictate the viability of securing a Bridge loan: the strength of the project and the borrowing entity. When combined they must give the lender a good comfort level, which means overall a fairly low risk.

To get a better understanding it might be best to put ourselves in the lender’s shoes for now. Pretend you have a large sum of savings and instead of keeping it in the bank you decide to lend it out for better returns. You know nothing about the “stranger” approaching you to borrow money from you. You know nothing about the city in which he’s planning to perform the project. Under what circumstances will you agree to lend your money to a person you don’t know in a city you’ve never set foot once before? Before you make that decision chances are you will want to evaluate how safe it is for you to get your money back and earn interest on it. Therefore, let’s go over the basics.

Where do you believe your money is best invested? Areas with many governmental restrictions and regulations are known to be unfriendly to business leading to high unemployment, poverty, high vacancy rates, and high crime. Would you feel comfortable to take that kind of risk? Or would you prefer a market with good economic data, such as low unemployment driven by strong local industries, low crimes rate, low occupancy rates and high absorption rates?

And how about the property? Remember, we’re thinking Bridge Loans therefore the property is one that is yet to be stabilized. Would you rather go with a completely vacant property – with no income being generated – or one that is, let’s say 50% occupied and which is still generating income? The first thing you’ll probably be wondering is what happens if you have to foreclose. In other words, what asset will you be left with if the borrower does not make good on his promise? One generating no income or one that still brings in some money while you’re trying to sell? I assume this is a no-brainer for you make the decision.

On the other hand let’s say you are approached by a borrower with years of experience (which he can prove) of buying and stabilizing vacant commercial projects. He has plenty of liquid reserves in the bank (aside from the down payment). This borrower knows well to have reserves for rainy days. He knows they almost always come, so he’s prepared. Would you lend your savings to him? You might but not before assuring yourself that he’s real and he can prove it to you. Would you charge a higher rate for the risk? You might.

As far as the borrowing entity you’ll probably not want to deal with one who has no experience owning and stabilizing properties. But what about one who has experience with residential homes? Is that experience good enough for you or would you be concerned with the difference between the residential and commercial markets? What about a borrower whose assets are not liquid but they are all trapped in real estate equity? Would you not be concerned with the possibility that projection errors could happen and the project might need additional funds (above and beyond your loan) for completion?

Another question you’ll ask yourself is at what percentage of the total project cost should you lend out? 100%, 95% or anything in the range or would you expect the borrower to share the risk and bring a substantial percentage of his own? Finally, what if the project and its location pass your test but the borrower does not give you the level of comfort you’d want? You’ll probably either say “No, thank you” or you may reduce the LTV and raise the interest you demand from him.

These are but just a few questions that will most likely be addressed and you’ll probably agree they do not stop here. When lending your own money you’ll evaluate each deal from all angles and you’ll be sure no stone is left unturned. My thoughts are overly simplified and I left out many case examples that are typically raised when a loan submission is evaluated by a lender. The idea is to answer some of the questions on the subject matter I often get from investors. If I were to wrap all lending in one word I’d say the one to refer to would be “risk”. I hope this will help you assess your future project’s risk from a lender’s perspective.

Contact me to discuss a potential Bridge Loan project.