Short-term financing vehicle aligns interests of lenders and borrowers.
The reality of fewer conventional lending sources, combined with mounting sentiment that more distressed real estate may be about to hit the marketplace, is driving a growing number of borrowers to pursue short-term refinancing solutions. Borrowers are doing so through bridge lenders, and these quasi-loan investors and lenders are busier today than in recent history.
Bridge lending was reduced to the role of sidekick to the conduit lending business during the height of the capital markets boom. At the time, conduit lenders were even able to package loans into securitization pools for partly vacant, incomplete or transitioning properties.
But an estimated $410 billion worth of commercial real estate loans are expected to come due in 2009, and many of these loans are projected to result in maturity defaults due to falling property values and borrower distress.
The preferred solution for many of these borrowers is a bridge loan. And loan investors are thriving on the hefty returns these products are fetching.
Bridge loans to refinance maturing loans can be quoted with interest rates upwards of 10%, and for maximum terms of only about 18 months, according to some bridge lenders. And with customary upfront fees reaching as high as 5%, investors making these loans can realize returns ranging from the mid- to high teens after all is said and done.
Yield-seeking investors can now buy a piece of this highly profitable bridge lending business through bridge loan funds. And short-term lending professionals with asset management backgrounds are the targets of these yield-hungry investors.
In an environment of falling property values, the risk of lending is quite apparent to both bridge loan fund managers and their investors. Qualified bridge lenders stand ready to take special loan servicing measures in the event a borrower is unable to meet the tightly controlled terms of these loans.
The measures can include a quick asset sale, repossession, or force the borrower to inject more funds into the deal. Bridge lenders often retain the right to step in and become an equity holder in lieu of demanding repayment if the borrower becomes distressed or defaults.
Strategic shift for investors
Buying into a bridge loan fund such as those offered through firms like Madison Realty Capital in New York, JCR Capital Partners in Denver, or Wrightwood Capital in Chicago can be an alternative to buying distressed properties or notes.
Instead of joining the legions of opportunity investors or opportunistic funds that are chasing messy distressed loans or properties, investors can achieve superior returns from bridge lending funds while avoiding costly repossessions and potential borrower litigation.
However, investors must do some homework when choosing the bridge lending fund in which to invest. They must know the ability of fund sponsors and managers to perform. At the core of a successful bridge loan fund should be at least one seasoned real estate professional with a background in ownership, management and development.
Real estate professionals can best understand the needs of the borrowers, the economics of each property, and how to devise an exit strategy in the event of problems in the performance and repayment of the bridge loan.
Property owners are in need of refinancing maturing loans, and the savvy bridge lender can be the ideal source. But this option comes with a cost in the form of high interest rates and hefty fees. Borrowers must be aware that the cost of borrowing has increased significantly for now.
Many loan requests today will likely fall into the laps of private short-term lenders seeking high risk-adjusted returns. These lenders are perfectly aware of the risk they are assuming. But unlike the many banks and conduit lenders that did not receive adequate compensation for the risk they underwrote during the boom years, private bridge lenders and bridge lending funds fully intend to avoid repeating the same mistakes.
W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.