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Bridge lending, also commonly referred to as bridge financing or bridge loans, is a staple of commercial real estate. These loans serve a valuable role in providing quickly needed capital to developers (the borrowers) and generating attractive returns to investors (the lenders). Despite their ubiquity in facilitating commercial real estate, there remains some confusion about bridge lending. In this post, we cover the basics from both sides, the borrowers and the lenders.
What is bridge lending?
Bridge lending, as its name implies, is a short-term loan. In the case of commercial real estate, it bridges the gap between property development or rehab and when that property can start generating income, usually in the form of rent. Once a property can generate cash flow, the developer can either switch to a traditional bank loan or agency loan, or engage in an exit strategy, such as selling the property.
Unlike traditional bank loans – think mortgages which can last 10 to 30 years – bridge loans have much shorter terms, anywhere from several weeks to 18 months. Because of their short-term nature and the expediency at which the funds are needed, bridge loan rates are also much higher than traditional bank loans, often 2x or more.
Why would a borrower want a bridge loan?
Assume you have a property that has solid potential to be built or rehabbed as workforce multi-family housing (a sector that is Fairbridge’s specialty). As the developer, you need capital fast to get the project moving. In real estate, timing and expediency is important.
- Speed: Every day that you delay in starting your project costs you in carrying expense and lost opportunity. The process for obtaining a bridge loan is much faster and less paperwork intensive than traditional bank loans. In fact, from application to funds being wired, the process can take as little as 10 days (vs 12-16 weeks for a traditional loan application). Construction draws are often received within 4-7 days with an experienced bridge lender versus up to a month with a traditional bank.
- Access: Would a bank even give you a loan? Banks often base their commercial loans on cash flow. But you’re not generating cash yet, you’re developing. Bridge lenders don’t make loans based on cash flow, they make loans based on property value or the “collateral”. An experienced bridge lender will have the most up-to-the-minute market intelligence to quickly estimate your property’s value and how much they’re willing to lend. And because the property serves as collateral, the vetting process does not need to be nearly as exhaustive.
- Resources: A crucial deciding factor in selecting a lender is also the value-added resources and inside local knowledge that they can provide to help a borrower avoid delays and added expense. A bridge lender with an institutional approach, like Fairbridge, helps developers move as quickly and responsibly as possible.
- Flexibility: Unlike traditional bank loans that come in a few standard variations, bridge lending is a more bespoke borrowing process. Bridge lenders with deep knowledge and experience understand the nuances of every commercial property and every situation. Therefore, they bring more creativity in designing a bridge loan that meets both a borrower’s and their investors’ needs.
Why would an investor want to participate in bridge lending?
With the potential for higher returns and a hard asset as collateral to protect principal, investing in a bridge lending opportunity can be a savvy part of a diversified alternative investment portfolio. However, just like every commercial property isn’t equal, every bridge lending opportunity isn’t equal either.
- Potential for attractive returns. Developers are willing to pay higher interest rates for speed and access. And because bridge lending is short-term, the delta on rates adds up to a very small fraction of their property’s eventual value. Investors reap the benefits from both the higher rates and non-correlated returns.
- Risk mitigation. At Fairbridge, we mitigate risk in several ways. It begins with our foundation: as a first lien debt holder, we stand before all others in getting recompense. Second, we’re conservative with leverage. Our loan-to-value ratio is typically 40-70% and, with a process that is richly data-driven, we have conviction in every valuation. Third, with a geographically diverse portfolio, our downside exposure on any one property or locale is limited. Fourth, we tour each property and meet each sponsor to minimize execution risk. We further reduce execution risk by nurturing relationships with repeat borrowers, building fluid communication processes and confidence in their execution capabilities.
- Asset selection. Fads in real estate come and go, but one area with both remarkable opportunity and robust resilience is workforce multifamily housing. According to DBRS Morningstar, there is a huge need for developers to build/rehab housing stock to solve the workforce housing crisis in the US. Note, this is not subsidized housing; rather it’s housing that the people who make up the fabric of communities – policemen, firemen, teachers, factory workers, and legions more – can afford.
- Liquidity. Alternative investments such as private equity and venture capital have multi-year lock-up periods. Private credit strategies focused on bridge lending generally have quarterly redemptions after an initial lock up period.
Ready to learn more about bridge lending?
If you want to go beyond the introductory basics – either about Fairbridge’s loan options or investment opportunities – contact us. With an experienced team and an institutional approach, Fairbridge is the modern standard for bridge lending.