Learn some basics around acquiring short-term financing from a bridge loan.
A bridge loan is an interim source of funding typically used to help real estate buyers bide time while selling property and buying another. Whether commercial or residential real estate, bridge loans essentially help you avoid liquidity restrictions and take advantage of time-sensitive opportunities—because in the commercial real estate market, timing can be everything.
While bridge loans aren’t ideal for everyone’s borrowing needs, there are quite a few benefits to consider—first of which is speed. The qualification and approval process for bridge loans tends to be considerably faster than applying for a traditional or equity-based loan. This speed provides flexibility in the market, allowing buyers to act quickly in opportune moments without worrying about unloading assets to free up budgets. In addition to speed and flexibility, you can elect to pay off your bridge loan in full before or after securing long-term financing.
An obvious disadvantage to bridge loans is cost. Bridge loans can be more expensive when compared to traditional lending. Be sure to become familiar with potential loan terms, as there are no set guidelines and bridge loans can vary widely in cost, terms, and conditions. In addition, be ready for some administration fees to add up, as well.
How to Qualify for a Commercial Bridge Loan
There is no one-size-fits-all solution to qualify for a commercial bridge loan. In fact, the whole idea of a bridge loan is to suit unique circumstances—from purchasing a property when cash isn’t an option to keeping a property financed while finishing renovations—so applying vague, step-by-step guidelines to secure a bridge loan wouldn’t help much. Instead, we impart a few items lenders identify potential bridge loan risk.
Debt Service Coverage Ratio
Your ability to repay a debt is the primary consideration when applying for a commercial real estate bridge loan. This is often measured by using the debt service coverage ratio (DSCR). The DSCR calculates the annual net operating income (NOI) of the property. The NOI must be sufficient to cover at least the annual carrying costs of the financing and lenders will typically require a ratio of 1.1 – 1.25 (100 percent coverage is: 1.00)
Net Worth / Cash Reserve
Lenders evaluate your financial strength and determine the collective net worth of you, or your partners, by reviewing financial statements. Lenders may also require proof of cash reserves to cover certain contingencies. Many lenders often hold back a certain amount of the loan proceeds as an interest rate reserve. This provides the lender a fund from which to draw monthly interest payments, while the property is in renovation status (if applicable)—and therefore not generating a profit.