Bridge loan
Also called Bridge financing, Bridge debt, Transitional loan.
A bridge loan is short-term, usually floating-rate debt that carries a property while its business plan is executed and is repaid by a sale or a permanent loan at stabilization. It funds capital in draws and carries an interest reserve, because the property cannot yet cover its own debt service.
How it works
Permanent lenders lend against income that exists. A property in a renovation, a lease-up or a rollover does not have that income yet, so the debt that carries it is priced and structured for the gap: floating over an index with a spread, terms of one to three years with extension options, and a rate cap that has to be bought up front and that has become materially more expensive as rate volatility rose.
Three moving parts distinguish it from a permanent loan. An initial advance funds the acquisition. A future funding facility reimburses capital as work is completed and inspected, which means the sponsor spends first. And an interest reserve funds debt service until the property covers it, sized off a projected cash flow that will not be the actual one if the plan runs late.
The exit is where the risk concentrates, because a bridge loan is repaid by a takeout sized on the same three tests as any loan, at rates in force on that day, against income the plan has to have delivered. Extension options are the shock absorber and they are conditional: a minimum coverage ratio, a minimum debt yield or a freshly purchased rate cap are typical conditions, and they get tested at exactly the moment the plan is behind.
Worked example
Illustrative value-add. Total project cost $59,420,000, a bridge commitment at 75 percent of cost, floating at 7.75 percent all in, $39,130,000 advanced at closing against the purchase and $2,520,000 of future funding for the renovation.
| Bridge commitment | $44,565,000 |
|---|---|
| Advanced at closing | $39,130,000 |
| Future funding for the renovation | $2,520,000 |
| Left for the interest reserve | $2,915,000 |
| Interest on the initial advance alone, per month | $252,715 |
| Months the reserve funds | 11.5 |
The reserve covers under a year of interest on the opening balance, and the balance grows as renovation draws fund. A plan needing eighteen months to deliver has a funding gap in month twelve that no lender is obliged to fill, and it opens while the property is still half renovated.
Conventions worth knowing
- Model the floating rate as a range rather than at today's index. A rate cap sets a ceiling, it does not set the rate, and the cap itself is a cost.
- Read the extension conditions before assuming the extension. An option conditioned on a coverage test the plan is behind on is not an option.
The common mistake
Underwriting the takeout at today's rates
A bridge deal is two financings and the second one is entirely in the future. Sizing the takeout on the current constant, the current cap rate and the plan's stabilized NOI stacks three optimistic assumptions onto the single event that repays the loan. Run the takeout at a stressed constant and on a stabilized NOI that misses the plan, and report the equity that has to appear if proceeds fall short, because that number is what the deal actually risks.
Related terms
- Loan to costLoan to cost is the loan amount divided by total project cost. It is the leverage constraint used on construction and heavy value-add loans, where the property has no stabilized value to lend against and cost is the only verifiable basis.
- Interest-only periodAn interest-only period is a stretch at the start of a loan during which the borrower pays interest and no principal. It raises early cash flow and coverage, and it ends with a step up in debt service that has to be modeled.
- Cash-out refinanceA cash-out refinance replaces an existing loan with a larger one and distributes the difference, after costs, to the owner. The new loan is sized by the same three tests that size any loan, applied to the property's income on the refinance date rather than at purchase.
- Renovation budgetA renovation budget is the funded capital a value-add plan spends to lift rents: the scope and cost per unit, the pace at which units can be delivered, and the rent premium the finished unit is expected to earn. It belongs in the sources and uses at closing, not in operating expenses.
- Stabilized NOIStabilized NOI is the net operating income a property produces once the business plan is finished: renovations delivered, lease-up complete, concessions burned off, rents at plan. It is the income a yield on cost is measured against and the income an exit value is usually built from.
- Loan sizingLoan sizing is the process of determining the maximum loan proceeds a property supports. A lender runs three independent tests, a loan-to-value cap, a minimum debt service coverage ratio at a stressed rate, and a minimum debt yield, and lends the lowest of the three.
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