Bridge Loans: What Are They and How Do They Work?

Let’s break down bridge loan basics

In its simplest form, a bridge loan is a short-term loan that gives the property owner time to complete a task, such as selling/ improving the commercial property or finding a new tenant. A standard commercial property bridge loan stretches from six months to one year, although many lenders grant extensions for six months to a year—usually for a small fee. 

Bridge loans are perfect for commercial property owners looking for interim funding and need to force their way into the next property transaction. Essentially, they help you avoid liquidity restrictions and take advantage of time-sensitive opportunities—because in the commercial real estate market, timing really is everything.

Typical bridge loan situations

While a quick application and approval can be very tempting, it should be noted that it usually entails a higher interest rate when compared to traditional lenders. Bridge loans aren’t ideal for everyone’s borrowing needs, but here are a couple common situations that we see bridge loans working well.

Real Estate Development

Need extra cash to meet crucial deadlines? Rather than stopping work, you can apply for an emergency bridge loan to avoid interruption and project delays. Short-term funding is typically used to:

  • Raise capital
  • Stall tax liabilities
  • Fulfill a business obligation
  • Seize a new real estate opportunity
  • Solve an emergency situation

Real Estate Investment

We often see borrowers’ projects stall when searching for a seller. Investors may find another commercial property while waiting on the first property to sell—in this case, a bridge loan supplies the capital to secure a new project while waiting on cash to come through from the previous property’s sale.

Let’s walk through a (simplified) scenario. . .

Let’s say you have a dilapidated 100-unit apartment complex running at 50 percent vacancy under contract at $7.5 million. Your team’s research uncovered that the property will likely be worth about $15 million after just $1.5 million in renovations. The updates should be completed within six months—after which you will raise rent to justify the post-renovation valuation. This is where a bridge loan can come in. You collateralize the subject property to get a $9 million commercial bridge loan to cover the purchase and the renovations. The work is completed and you’re able to lease-up the building to over 90% occupancy, and then refinance the property with $15 million permanent financing (most likely in the form of a conventional commercial loan) based on the increased post-renovation valuation. From there you’re able to pay back your original bridge loan in full.

Qualifying for a commercial bridge loan

While the approval process for a bridge loan is significantly less stringent than traditional bank lenders, there are a few items lenders identify to rule out risky possibilities.

Debt Service Coverage Ratio

A borrower’s ability to repay the debt is the primary qualifier for commercial real estate bridge loans. This is most often measured by using the debt service coverage ratio (DSCR)—which 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. 100% coverage is expressed as 1.00, and lenders will typically require a ratio of 1.1 – 1.25.

Net Worth / Cash Reserve

Lenders evaluate the financial strength and determine the collective net worth of the individual or group applying by reviewing financial statements. Lenders may also require proof of cash reserves to cover certain contingencies. 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—and therefore not generating a profit.

Credit Score

Your credit score—while key in traditional types of financing—doesn’t play a significant role for commercial bridge loans. That said, most bridge loan providers will check your credit, and will expect a credit score above 650. Your DSCR and net worth far outweigh your credit score when bridge loan lenders are considering your application. 

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