A bridge loan or bridge debt is a useful short-term loan used until a buyer can secure more permanent financing. The standard term on these bridge loans is 3 years, depending on the lender, with two 1-year extensions. It is important to know the terms of loan that the lender provides so you can plan accordingly. Once the term is up the loan becomes due unless there is an option to extend it. The volume of bridge loans has increased significantly in the second half of 2021.
Forward Looking
The ability to get bridge loans is based on the story of the property and what the business plan is. It is acceptable to some bridge lenders to have a lower Debt Service Coverage Ratio (DSCR = Net Operating Income divided by debt service) than a typical 1.25 ratio. That means the property might be struggling to keep up with its loan payments but if you have a plan to correct that by year 2 or year 3 then you can get the loan. This is good for an apartment buyer that wants to buy a distressed asset that would not qualify for traditional agency financing from Fannie Mae or Freddie Mac.
Another metric the bridge lenders will look at for debt service is the Debt Yield (DY = Net Operating Income divided by total loan amount). Let’s say the Net Operating Income is $500,000 and the loan amount is $10,000,000:
DY = $500,000/$10,000,000 = .05 or 5%.
Some bridge lenders will have a minimum debt yield at purchase and require that debt yield to be higher in year 2 or 3 based on the pro forma or what you think you can do with the property. Typically, the lender will want to see a minimum debt yield of 7% by year 3.
Rising Rents
Rents across most of the nation have risen significantly over the last year and look to continue to rise depending on the market. The southeast is seeing a lot of inbound migration and demand will likely continue to increase in those areas.
Some buyers are choosing to go with bridge loans and forgo longer term agency debt because of the state of the market. You can increase the value of an apartment complex faster with rising rental rates without significant capital expenditure. Once the target equity multiple or return objective is achieved it might be time to sell or do a cash-out refinance and return some of the investor’s money. That is the flexibility that a bridge loan would provide for a borrower.
In & Out
The syndication model is prevalent in the buying and selling of apartments and that model is typically a 5-year hold. In this holding period of 5 years the General Partners (GP’s) would like to try and double their investors money. This is typically achieved by having an Internal Rate of Return (IRR) of 15% per year. By using the rule of 72 (time in years to double an investment) you can see that a 15% return per year will double your money in 4.8 years. 72 (rule) divided by 15 (IRR) = 4.8 years.
With the rapid rise of rents, the IRR could be higher, and a GP could potentially double your money in 2-3 years in some markets if current trends continue. This is the reason bridge loans are hot right now. A bridge loan can get you in and out of a deal in 3 to 5 years or refinanced to long term after capturing the value by raising rents.
The bridge loans might require a rate cap, but they do not have the high prepayment penalties that the agency loans currently have. If your plan is to get in and out by year 3 to capitalize on rent growth, then you will likely face a high prepayment penalty or yield maintenance with an agency loan. This prepayment penalty would lower the overall return to the investors.
Conclusion
Bridge loans are a hot commodity at the time of this writing. Bridge lenders are backed up which is causing them to do only larger bridge loans or charge higher interest rates for smaller loans. If the loan you want is under $10 to $15 million it might be better to go with a bank recourse loan or maybe a Freddie Small Balance Loan ($1M to $7.5M), but if you are in that $15 million and above range a bridge loan is a good option for apartment buyers right now. A good mortgage broker can help find the right loan for you!
