Beyond stock, bonds and other traditional investment vehicles, accredited individual and institutional investors should consider allocating a portion of their net worth to bridge loans. It is one area where experienced investors are likely to find stable, uncorrelated returns compared to many other fixed-income investments.
What is a bridge loan?
A bridge loan – also/formerly known as a hard money loan – is short-term debt secured by a lien on commercial real estate. These quick-close, short-term loans are designed to temporarily “bridge the gap” as borrowers pursue a sale of the collateral or seek permanent financing from a traditional bank or other government-backed lending source.
Bridge loans behave uniquely in several ways. They will typically:
- Close in 10-30 days
- Have maturities of 12-24 months
- Have loan-to-value ratios of 40-70%
- Have interest rates of 10-13%
- Have origination fees of 1-3%
Most bridge loans also carry some value-add component as a “use” for the proceeds of the loan. As a result, many Fairbridge clients use bridge loans to make improvements that add significant value to the underlying collateral of the loan.
Are bridge loans a good investment?
Prior to the Great Financial Crisis (“GFC”), the bridge loan business was mostly dominated by small investors making loans to local developers and investors. As banking emerged from the GFC with extensive new regulations, the industry attracted more institutional private credit lenders like Fairbridge Asset Management.
With more players in the market, bridge loans are a viable investment platform for a wide range of investors, including accredited individuals, institutional investors, IRAs, pension funds and more. That said, the sub-$25MM loan size segment of the market is still extremely fragmented, providing better structuring opportunities at higher rates. Fairbridge brings an institutional approach to this market segment and strategizes to provide investors with access to higher yields and better structure, similar to loans in the highly competitive $25MM+ segment.
Why should bridge loans be part of your investment portfolio?
- Maximize risk protection. Priority repayments.
Bridge loans are secured, asset-based investments. Bridge lenders seek to maximize downside protection for investor principle by issuing mostly first-lien loans collateralized by residential real estate. First-lien debt means bridge loan investors are entitled to repayment before all other creditors (even other senior debt-holders).
- Decorrelation from overall market risk
Bridge loans are uncorrelated to the market and do not necessarily follow S&P trends. In fact, bridge loans tend to be inversely correlated to the market, meaning lenders like Fairbridge excel as traditional lenders pull back. At present, we are in a unique lending environment: the U.S. is experiencing a nationwide housing shortage, which has made residential real estate highly valuable, and there is more demand for loans than the traditional market funding sources can support. This places balance sheet lenders like Fairbridge in a great position to originate a strong vintage of loans.
- Lower loan-to-value ratio
The lower loan-to-value ratio of bridge loans offers further downside protection. Fairbridge, for example, issues loans at 40 to 70% LTV, with a portfolio-wide average of 55%, so even in the event of a significant value loss (or even a default), we are well positioned to recover investor principal in addition to default interest.
How do bridge lenders protect their investors?
Historically, bridge lenders strategize against three key threats:
- A systemic and correlated market failure,
- Poorly chosen collateral, and
- Being overleveraged. Even in the wake of a worst-case scenario, like the GFC in 2008, many bridge lenders were able to recover all of investor principle – it simply took time.
Risk management & returns projections
Well-disciplined lenders can deliver consistent returns across their portfolio above 10%, while specific deals with leverage are capable of returns in the high teens. This is achieved with low-leverage loans featuring less risk than providing equity to real estate investments – which itself can provide similar returns, but at much greater risk.
Bridge Lending Considerations
All bridge lenders should consider a few factors when investing in bridge loans. Of course, excess leverage can be detrimental to any investment made. While Fairbridge utilizes some leverage, it is very conservative – in the range of 0-25% debt-to-equity ratios. Another risk in bridge lending is lending at high loan-to-values (LTV). At Fairbridge, we target loan-to-values in the 40-70% range and the historical weighted average LTV of the portfolio has been in the 50-60% range. This provides ample collateral coverage for our loans.
Lending secured by non-traditional collateral that can be difficult to value and/or dispose of in a foreclosure scenario can also be risky. At Fairbridge, we focus on single- and multifamily collateral with high demand due to the housing shortage in the U.S. and many valuation data points. We have very little office or retail loan exposures.
Lastly, lending can be done in geographical locations that are less established or are in decline. At Fairbridge, we seek to target markets that are gateway growth cities or already established housing markets with readily identifiable valuation metrics.
At Fairbridge, in addition to the traditional due diligence processes, our underwriting and approval process includes personally visiting subject properties and meeting with the sponsorship groups. Knowing the people and the property on a personal level matters, and our level of involvement makes us more akin to co-investors than a lender. Borrowers have often commented to us during visits that we are the first lenders they have worked with who knew construction and walked the property in detail.
Who can invest in bridge loans?
Generally, accredited investors and institutional investors can invest in bridge loans through various types of investment vehicles. Fairbridge Asset Management has extensive experience in the bridge lending sector. If you want to learn more about bridge lending, contact firstname.lastname@example.org.