Bridge loans make up a large part of today’s multifamily lending environment. The data below shows just how big of an impact they are making in the market (CRE CLOs are bridge lenders).
In 2021, $45 Billion in deals were bridge loans versus $129 Billion in agency debt. This year is on pace to match with $24 Billion already issued in bridge loans.
Rate Caps
Majority of bridge loans are priced on a floating rate basis. The recent rate hikes have impacted the overall interest rate on these loans. A typical bridge loan spread is around 400 basis points over an index such as SOFR. The floating rate used to be a LIBOR index but is in the process of moving completely to SOFR in the US.
Bridge loan spreads could be lower in the 300’s but since most of them must securitize and sell the paper back to the market, spreads are moving up. This is due to the market not wanting to assume the risk and therefore is demanding a higher return. Lenders increase the spread to make it more appetizing when going back to the market to sell the securities.
In addition to increasing spreads, the major banks that are providing the credit to the bridge lenders are requiring rate caps. Rate caps basically cap the amount of interest you pay on the loan, but it is starting to come at a hefty price.
This makes you wonder if the cap costs are worth it. Let us look at an illustration for a $25 Million loan:
From this example it shows that the net benefit for a 3-year cap at a 2% strike is not in the money. You are protected if interest rates go higher but based on the forward curve it looks like a bust. In addition, you have to pay that cap cost at closing, so you also are affected negatively by the time value of money.
Conclusion
The rate caps are currently a thorn in the side of deals. Lenders are requiring them in most cases. The strength of the borrower determines what kind of negotiating power they have. A strong borrower might not be required to have a cap. A newer multifamily syndicator might not have a choice. I think each borrower needs to weigh the pros and cons and determine their level of risk whether to let it float or not.
