Ask the Advisor: Is a bridge loan right for me?
As the real estate market rebounds, bridge loans can provide an interim financing option for investors and developers until they're able to secure long-term financing. While such loans provide several benefits, they also come with some disadvantages worth weighing before jumping into the loan.
Advantages of Bridge Loans
Bridge loans are particularly attractive these days for investors in underperforming multifamily properties. Traditional lenders prefer more stabilized properties, thus making it difficult to obtain financing to increase occupancy, make improvements or retain smarter management. A bridge loan running from 12 to 24 months can give investors the opportunity to address the issues necessary to stabilize a property to the satisfaction of traditional lenders.
Bridge loans are also appealing because of the borrower's ability to choose repayment options. A borrower can opt to repay the loan before or after long-term financing is found. If the borrower takes the former option, it can improve its credit rating by making the payments on time, thereby improving its odds of qualifying for long-term loans with favorable terms. If the bridge loan is to be paid off after long-term financing is secured, part of that financing can be applied to repay the loan.
Such loans typically require less income documentation than conventional loans and tend to close quickly. They also can be nonrecourse, to protect the borrower's other assets.
Not surprisingly, bridge loans feature higher interest rates, fees and penalties, and generally require a large balloon payment. Closing costs are usually high and can't be recovered if you find long-term financing sooner than expected. Bridge loans also require a high loan-to-value ratio and put you at risk of losing your property over a relatively small loan amount.
If you choose to pay off the bridge loan after obtaining long-term financing, you will incur greater interest expense. And if the long-term financing falls through, you'll be left scrambling to make the payment out of your own pocket.
Proceed with Caution
Only savvy, well-capitalized borrowers should consider bridge loans. The loans are especially appropriate for newer, large multifamily properties (at least 100 units) in stable or improving markets with solid and expanding employment bases.
For the right kind of borrower and right kind of project, a bridge loan could be just the ticket. Your financial advisor can help you determine if such financing is worth pursuing.
For questions or to discuss a real estate issue, please contact Doug Collins, CPA and Partner on (973) 328-1825.