Seasoned real estate investors generally have no trouble finding deals. They have strong networks they can leverage to source new leads, and systems and processes in place to identify opportunities before they hit the market. Once these deals come to fruition, the big challenge is often financing the projects.
This is particularly true for fix-and-flip investors. The best deals usually require investors to pay cash, and then they must have the additional capital needed to improve the property prior to resale. This can tie up most, if not all, of an investor’s capital which can limit their ability to put other deals under contract. Access to capital, or lack thereof, is one of the primary obstacles fix-and-flip investors face when trying to scale their businesses.
Bridge loans can be a valuable tool for real estate investors who need additional access to capital.
WHAT ARE BRIDGE LOANS?
Bridge loans are a type of short-term loan that can be used by real estate investors for the acquisition and/or renovation of property. Loans are intended to provide investors with the capital they need to execute their business plan, and are generally repaid once the property is refinanced or sold.
Short-term bridge loans can be used for all property types, including multifamily, office, industrial, retail, hotel, self-storage, mobile home parks and land development. They are also a popular source of financing for fix-and-flip investors who purchase a property with the intent to quickly renovate and then resell for a profit.
As the name implies, bridge loans are intended to “bridge” the gap an investor faces when trying to line up the equity needed to purchase, renovate and then stabilize a property.
Bridge lenders are typically able to provide highly customized loans with rapid speed, which makes them particularly attractive to real estate investors who need to act quickly. Bridge loans can be closed much faster and with less paperwork than more traditional bank loans.
WHAT ARE THE TYPICAL TERMS OF A SHORT-TERM BRIDGE LOAN?
Bridge loans are used by real estate investors of all kinds. The length of the bridge loan will generally depend on the nature of the deal. For example, someone repositioning a large commercial property might need two or three years to execute their business plan. Someone flipping single family homes might only need six or eight months. Accordingly, some bridge loans are structured with three-year terms (sometimes with two one-year options to renew) whereas others are amortized over 12 months or less.
Bridge loans usually have higher interest rates than traditional commercial loans. The rates are generally 50 to 200 basis points higher than what you might expect with a conventional bank loan, with the actual rate depending on the specifics of the deal. Highly-levered or otherwise higher-risk deals will generally have higher interest rates, and vice versa. The rate also depends on the source of the loan. Hard money lenders will usually charge higher rates than private money or traditional banks – all of which tend to have their own bridge loan products.
Fix-and-flip borrowers should expect to pay about $500 for the bridge lender’s appraisal fee and then other miscellaneous fees ranging from 2- to 5% of the loan value, depending on closing costs.
HOW DO BRIDGE LOANS WORK?
Bridge loans are usually made based on loan-to-value (LTV) or after-repair-value (ARV). Unlike traditional bank loans, which are based on a property’s current value or cash flows, bridge loans are made based on a property’s future value. Most bridge lenders will cap an ARV loan at between 65 and 70 percent of the property’s projected ARV.
For example, let’s say an investor plans to purchase a property for $100,000 and then invest another $50,000 in renovations. The investor believes that the ARV will then be closer to $200,000 based on local market comps. Assuming the lender agrees with your underwriting, they may offer a bridge loan at 65% of the ARV, or a loan of $130,000. The investor will have to come up with the remaining $20,000 – but that will be their only out-of-pocket cost, and may be spent at the tail-end of renovations rather than up-front with the acquisition.
Given the focus on ARV, it is important for borrowers to have a business plan to share with the lender to indicate how they plan to achieve their intended ARV. The lender will then look at several factors, including the property, the renovation plans, the local market upon which the pricing is derived, local comps, and the borrower’s experience.
When evaluating a borrower’s experience, the lender will consider how many deals the sponsor has done. They will look at whether the borrower has done similar deals with similar product types in similar geographies. The lender will also look at the borrower’s credit profile, including their other cash reserves or liquid assets. These factors help the lender assign a risk level to the deal. Higher-risk borrowers are still eligible for bridge loans, but the loan might be at a higher rate or with more restrictive terms.
Bridge lenders will also usually expect the borrower to have at least 20% of their own equity in the deal, usually put toward the property acquisition.
COMMON USES FOR BRIDGE LOANS
Real estate investors can use bridge loans for a variety of purposes. These are the most common reasons for using a bridge loan:
- You need access to capital quickly.
Time is money—and a bridge loan can help a borrower move forward faster than if they were to try to line up traditional financing. Short-term bridge loans are one of the easiest and most secure ways of financing short-term projects. Some bridge loans can be closed and fully funded in two weeks or less compared to a traditional lender, where loans generally take at least 45 to 60 days to close. The fast processing time of bridge loans is a major advantage to this type of financing, and are an ideal source of capital for those competing for deals on an “all cash” basis.
- Your deal is unconventional.
Bridge loans are highly flexible in nature, and therefore, are a great source of financing when someone has an unconventional deal. This might include the purchase and renovation of a sober living home or student housing. These properties can be difficult to finance and come under great scrutiny by traditional lenders. Whereas traditional lenders have more restrictive loan terms that usually require loan committee approval, bridge lenders can be nimbler and provide terms that are customized to the deal in question.
- Your value-add strategy forecasts strong future cash flows.
A common real estate investment strategy is to buy a Class B or C property and then execute a “value add” strategy that improves the property to Class A or B quality. Value-add strategies require some combination of physical and operational improvements that together, help to stabilize the property. Repositioning efforts like these are ideal for value-add investors whose business plan anticipates strong future cash flows and increased property value. Unlike conventional lenders who prefer to finance stabilized properties, bridge lenders are usually more comfortable taking on the risk associated with lending on a deal based on future cash flows (something that can be projected but never guaranteed).
- You need a non-recourse loan.
There are two types of loans: recourse and non-recourse. Recourse loans require that a borrower put up sufficient collateral to make the lender whole in the event of default. This could include a borrower’s other investments, retirement accounts, cash reserves and more. Non-recourse loans, on the other hand, limit the borrower’s liability to the property being financed. Most borrowers prefer non-recourse loans as there is no burden of repaying the loan using other assets unrelated to that deal.
- You have poor credit.
Short-term bridge loans are excellent solutions for investors whose credit scores do not meet the thresholds of a conventional lender. While a bank or agency lender (e.g., Fannie Mae or Freddie Mac) might not approve a loan for this reason, a bridge lender is usually more willing to work with someone regardless of their credit score or credit history. A bridge lender’s underwriting process leans heavily on the ARV of the asset and less on the credit profile of the borrower.
Real World Bridge Loan Scenarios
Example 1: Buying Your Next Fix-and-Flip before Selling Your Current Flip
Let’s say it’s Friday when you tour a three-bedroom, two-bathroom home listed for $125,000. After seeing the property, you anticipate that a most $20,000 investment could make this home shine, in which case you could then sell it for $200,000 – a staggering $55,000 profit. The renovations would only take you 30 days to complete. Unlike some of your other deals, this property is publicly listed and the broker has asked for final and best offers by Monday at noon. In order to be competitive, you plan to offer the full asking price and pledge a full-cash offer with a two-week close. The only problem is… you’re still working your way through the punch list on your current flip and don’t have the cash on hand to close that quickly. Even in a best case scenario, it will take longer than two weeks for your current flip to sell, so you won’t have the cash ready to start the renovation on this next property if you get it. This is where a bridge loan might make sense.
In this case, a short-term bridge loan for $150,000 would be enough to cover the acquisition, closing costs, and all anticipated repairs. A bridge loan would allow you to fulfill your promise of closing in two weeks, with all cash, and then your contractors could get started as soon as they button up the final details on your current property. You could then use the proceeds from the sale of your current flip to pay off the bridge loan (or not – you might want to keep that cash liquid and use the proceeds from the sale of this next flip to pay back the bridge loan in full). In any event, the marginally higher interest rates available through bridge loans are worth it if it means you can capitalize on great opportunities as they arise.
Example 2: A Wholesaler is Rapidly Growing their Business
Bridge loans are mostly used by real estate investors looking to acquire, renovate, and then quickly re-sell a property. But they can also be used by wholesalers. One of the reasons people get into wholesaling is that it does not require significant up-front capital. There are some cases, though, in which a wholesaler pounds the pavement so hard that they land several opportunities at once. To put a property under contract, the wholesaler must put down a deposit that is then held in escrow. Let’s say a wholesaler identifies four deals, and collectively, this requires them to put down $40,000 in earnest money. The wholesaler already has the bulk of their cash tied up in other wholesale deals and is still waiting for those deals to close.
Once again, this is a great reason to use a bridge loan. In this case, a wholesaler might approach a hard money lender about a short-term bridge loan that is used for the explicit purpose of making the deposits needed to put the properties under contract. The bridge loans would be repaid in short order once the wholesaler assigns the loans to other investors.
Is a short-term bridge loan right for you?
Any real estate investor will want to weigh the pros and cons of bridge loans carefully. While bridge loans are an excellent source of capital under certain circumstances, they do not come without their own risks. We noted their higher-than-market interest rates, but they also tend to charge steep fees for late payments. If you are not highly confident in your business plan and exit strategy, a bridge loan might not be the best for you. You must be able to execute on time and within budget.
That said, for most borrowers in need of short-term capital, bridge loans are an attractive option. As you’ve seen here, they can be used for a range of situations. They are especially useful for fix-and-flip investors looking to scale their business.
As always, borrowers should consider all of their financing alternatives before making a decision. When in doubt, consult with several lenders to explore your options.