Property investors who have never owned commercial property before may not realize that commercial loans are typically far shorter in length than their residential counterparts. While a standard commercial mortgage may last from five to seven years, borrowers also have the opportunity to secure financing for an even shorter period of time.
These transitional loans, which are commonly referred to as “bridge loans” within the industry, are stop-gap solutions that give investors and small business owners the funds needed to improve or re-tenant their commercial property so they can get approved for a more attractive, long-term mortgage.
Those who are currently struggling to secure a commercial loan due to a lack of property stabilization or high vacancy rates can work with a bridge lender to better position themselves for future success. However, before prospective borrowers can get started, they need to know how these loans work and what they can do to improve their chances of getting approved.
The Bridge Loan Rundown
Commercial bridge loans can be smaller in scale (think $1 million to $5 million) or as lofty as any traditional, large-scale commercial mortgage. Regardless of the dollar amount, these loans typically have terms of one to three years. Due to the short-term nature and increased risk, bridge loans usually come with a higher interest rate than is typical with a traditional commercial loan.
A Commercial Case Study
Consider the investor who identifies a small apartment building they would like to purchase to diversify their portfolio and establish a passive revenue stream. The property is only 50% occupied and is in need of some repairs. The investor initially approaches their bank but they are issued a rejection based on the state of the property.
The investor decides not to keep shopping the loan to other banks. Instead, they take out a one-year bridge loan for the acquisition, use some of the funds to make cosmetic improvements, and market the apartment building to new tenants. Once the property is refurbished and fully-tenanted, the investor is able to take the bridge loan out with a long-term solution using the same bank that rejected them just one year earlier.
This is just one example of how a transitional financing solution can help borrowers in both the near and long terms.
Who Offers Bridge Loans?
Borrowers can secure bridge loans from many different types of lenders – such as traditional banks, alternative non-bank institutions, and hard/private money lenders.
Investors and business owners who are familiar with the differences between bank and non-bank alternative lenders should not be surprised to find that traditional bank bridge loan programs typically feature lower rates and a greater number of restrictions.
Since transitional loans by their nature require flexibility and an increased amount of risk, borrowers often find that non-bank lenders are well-positioned to offer attractive bridge loan solutions as well. While these programs will likely be more expensive than bank options, they can also include a number of key benefits having to do with transaction speed, increased proceeds/leverage, or required documentation.
The best option for any investor or small business owner will always be the one that solves for the greatest number of their specific needs. In many cases, this analysis will need to go beyond interest rate – a bridge loan program’s full set of benefits and drawbacks should be considered.
Start with the Exit Strategy
When seeking transitional financing for a commercial property, prospective borrowers must first be able to articulate a clear exit strategy for potential lender partners.
Lenders need to have a full understanding of a borrower’s plans for when the bridge loan comes due. Common exit strategies include:
- Refinancing with a different lender
- Selling the improved property for a profit
- Paying off the loan with other income
A prospective borrower can instill confidence in lenders by describing their exit strategy in detail early on in the application process. Experienced lenders can then help shape the borrower’s plan and improve their chances for success.
Small business owners and investors in need of commercial mortgage financing should consider bridge solutions in cases where their property is experiencing stabilization or vacancy issues. While transitional in scope, this type of loan could help position them for sustained success.
Leslie Smith is Managing Director of Commercial Direct. She led the launch of Silver Hill Funding in 2016, and is building on that experience to spearhead the launch of the consumer-facing direct lender, Commercial Direct.
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