A commercial bridge loan is asset-based financing that is used by enterprises that are not eligible for other investments to run their business operations. These loans carry a considerable risk margin, but they come in handy where a company needs to invest or complete an ongoing project, but they have used up their lines of credit.
In this article, Money Lender Loans will look at commercial bridge loans, how they work, their pros and cons, and give a verdict to guide you in making an informed decision. We have been offering professional lending services to businesses and entrepreneurs across Orange County, California.
What is a Commercial Bridge Loan?
A commercial bridge loan gives financing to buy a commercial property that requires significant upgrading or remodeling before it can be used again. It acts as interim funding to purchase commercial real estate for the time being without using it as the permanent financing solution.
Commercial bridging loans (also called business bridge loans) generally fit the description of bridge loans, but they are explicitly for business expenses. They are expensive, and borrowers should use them to address time-pressing financial issues then refinance or repay them as quickly as possible.
Please note, the term ‘bridge' refers to how the borrower uses the money and not specifying the specific characteristics of this loan facility. Commercial bridge loans usually have a repayment period of 6 months to 3 years after which the borrower is expected to have secured permanent financing or at least offloaded the real estate.
Types of Bridge Loans
There are two significant kinds of or business bridge loan facilities:
- Closed bridge loan – this type is beloved by lenders since it has more assurance of repayment attached to it. A closed bridge loan is given for a predetermined duration as discussed and agreed upon by the borrower and lending company. Subsequently, their interest rates are lower, but the financial penalties for breaching the terms are more severe.
- Open Bridge Loan - open bridge financing is availed without a fixed time frame and therefore fetches a higher price tag than its counterpart. Lenders are keen to safeguard the security of their money, so they deduct the interest from the funds they advance your business. If you are unsure about getting approval for a traditional loan product, an open bridge loan is the next best thing to solve pressing capital deficits.
What are the Characteristics of Commercial Bridge Loans?
Before we delve into why you need a bridge loan, let us understand their two main features.
- Fast Access
These loans are quick to fund so you can take care of whatever business matter needs an influx of cash. Borrowers of these loans, therefore, need to look beyond traditional sources to less conventional modes of funding their businesses.
Traditional lenders such as banks usually take their time before approving loans – even several months – and you don't have the luxury of time. Some short-term lenders can give funding within 24 hours, and a select few may need more than a week to process the commercial bridge loan.
- Prepayment Incentives
The other main feature of bridge loans is the benefit of paying off early to avoid the hefty interest rates. Commercial bridge loans come with a factor rate, which means the interest rate is set and therefore, getting a prepayment discount helps a lot.
Why are Commercial Bridge Loans Necessary?
Commercial mortgage bridge loans come in handy when a real estate property is far run down to qualify for permanent financing. The owner uses this influx of cash to renovate the property so it can meet the standards that prospective clients are seeking — for instance, renovating a building to bring it up to code, so it fetches a higher income that improves your eligibility for permanent financing.
- Buying Real Estate
You may have a chance to buy real estate, but you don't have enough money for a down payment but need to act fast before the property goes off the market. A bridge loan can help you get this new property before it's snatched up in a competitive real estate market. This facility allows entrepreneurs to take full advantage of real estate investment opportunities that come their way even when they are not financially ready.
- Preparing for acquisition
Gearing up for a purchase is yet another reason why this loan product is essential. If things have been slow for several years and you have found a buyer who can turn things around, you need to tidy things up before the buy-out.
- Buying Inventory
You may have an opportunity to purchase huge volumes of stock at a discounted rate, and this venture calls for vast amounts of capital. If this money is not forthcoming, you may need to get a bridge loan soonest possible.
Apart from getting a head start in renovations, stocking inventory, readying for acquisition, and preparing for permanent financing, borrowers can seek these loans under the following circumstances:
- The real estate property does not meet the desired occupancy rates
- Your credit profile is not satisfactory and therefore needs boosting
- Waiting for permanent financing is not a feasible option
- You don't own the real estate alone; there are partners involved
- Business Expansion
After a couple of years growing the business and accruing a decent profit, you may feel it's time to expand to a new location or expand the product line. Do you save up painstakingly until you hit the financial target or do you take out a loan? Bridge loans help to speed up the timeline so you can enter the target market now as opposed to a few months or years when the opportunities are taken.
Bridge loans are conventional among venture capitalists for the same reasons listed above. They can keep the business afloat, so there is operational money during consecutive private equity financing. Also, these funds help distressed companies to keep running as they find a suitable acquirer or an investor who can revive the business. Companies gearing up for an initial public offering (IPO) may take a transitional loan for debt financing ahead of this big move.
What is the Qualifying Criteria for Commercial Bridge Loans?
As explained above, bridge loans are a life-saver that can help your enterprise stay running as you find a suitable investor. They can also help you to take advantage of a real estate opportunity, and much more. The qualifying criteria are not comfortable, and prospective candidates must fulfill these requirements:
- Cash Reserves
It is not atypical for lenders to demand proof that your cash reserves are can cover contingencies like replacement reserves. Lenders will retain a stipulated amount of proceeds from the loan and use this as an interest rate reserve to cover themselves if the repayment falls through.
With this portion of interest rate reserves, the moneylender can draw monthly interest payments as the real estate in question is being remodeled and therefore with little to no occupancy rate. The requirement for cash reserves helps with cash flow so the lender's business can run without a hitch as they await installments.
- Time in Business
How long have you been running this company? This question and others are the mainstays of discussions with money lenders as they want to be clear that you know are legitimate. The longer you have been running this venture – as a solo entrepreneur or otherwise – the better for money lenders.
Before the lender is completely sold on your pitch, they will need to know about your experience in handling a project of this magnitude. If you are renovating a rundown building in an unsavory part of town, they will want to gauge your ability to handle such projects.
You need to impress them with considerable experience as this will influence how much financing they can approve. More so, experience correlates with how much cash reserves you need to have. If neither you nor your business associates have experience with such an undertaking, the moneylender will not provide the loan. Without a proven track record to inform their decision-making, the gentrification project will be deemed a risky investment.
- Debt Service Coverage Ratio (DSCR)
Just like a regular loan from traditional lenders, money lenders will need to be confident of your ability to honor this obligation without any troubles. Legal matters are arduous not to mention expensive, and therefore, the moneylender wants to be convinced that your debt service ratio is satisfactory.
DSCR is computed using the debt service coverage ratio (DSCR), and it measures the Net operating income (NOI) of your real estate per year. NOI is the total earnings from rent minus taxes, utility bills, repairs and maintenance, insurance, etc. NOI can also include a vacancy factor for residential or commercial property.
At the bare minimum, the NOI must cover the carrying costs for this loan year on year and total coverage is expressed as 1.00. Lenders usually demand you score an NOI ratio of 1.1 – 1.25 before approving financing for your enterprise.
- Personal and Project Documentation
The next qualifying component for commercial bridge loans is submitting the necessary own and project documentation. Every principal will give their recent tax returns, credit reports, and resume detailing their role in the business and experience handling the project at hand.
You will also provide documentation for the project and property as follows:
- Executive summary for the project
- Itemized budget of the modernizing costs and timelines
- Earnings and expense reports from the former owner
- Schedule of leases (e.g., monthly, quarterly, or annually)
- Rent rolls
- Exit strategy (e.g., reselling the property or refinancing)
After issuing these documents, the lending company will launch into the next stage, where they appraise the property and hire an experienced real estate broker. The goal is to get detailed information about the real estate market from the best local agents. Surveying the building and conducting routine title searches and insurance is integral to this screening process.
- Net Worth
Your cumulative net worth is another vital requirement as a bridge loan usually does not exceed this amount for practical reasons. When applying for a bridge loan, the lender will ask for financial statements on all principals to verify each person's gross assets.
Lenders use this information to determine the financial strength of the business (owners and associates) that is applying for financing. If you don't know how much your net worth is, we advise you compute this using open source computing worksheets online. Alternatively, you can consult a qualified financial expert to assist. Beware of exaggerations as these will only get you so far; submitting falsified documents will spook the would-be lender.
Getting a clear picture of your net worth also helps you identify what assets you can offer as collateral and which business associate can sign over what property. In most cases, the lender will not use the full value of insurance, so they compute a loan to value ratio for this hard money loan. If the asset offered as collateral is not valuable enough, the borrower is tasked with providing more personal assets to secure the loan.
- Credit Score
Unlike regular bank loans, the eligibility criteria for money lender loans are not based on your creditworthiness. Lenders will still check your credit score but to validate that refinancing the loan with a permanent loan option is a feasible exit strategy for your business. Not to worry though, having a credit rating of 650 and above is not the first criteria for a bridge loan but rather how much collateral you can offer.
Advantages of Commercial Bridge Loans
Business bridge loans are used as an interim solution before securing permanent financing as you prepare to execute a long-term investment strategy.
- Temporary Loan
As the name suggests, a transitional loan is temporary and usually spans less than twelve months. The borrower leverages their existing sellable assets as collateral, so they qualify for urgent financing then pay off the loan once they offload the said asset.
- Enhancing Value
These transitional loans can add significant value to a rundown property by getting the much-needed repairs that enhance the appearance of the property. You can then list it when the market is doing well and get substantial returns that will recoup the upgrading expenses.
- Contract of Sale
When selling off one property to acquire a new one, there is a risk of not offloading the previous property before the loan expires. You can minimize this risk by getting a binding contract of sale or by examining the real estate market so you can make an informed estimate of the transaction timelines.
- No Monthly Repayment
Most lenders don't ask for monthly installments but rather allow borrowers to pay after their target asset goes off the market. This arrangement works pretty well if you are not in a position to handle the financial burden of servicing a loan every month, perhaps due to an economic slump.
Disadvantages of a Commercial Bridge Loan
- Higher Interest Rate
These loans have a quicker turnaround than regular ones so borrowers can expect to pay a higher interest rate, which makes bridge loans more expensive. Therefore, you need to factor in the extra cash to see if you can manage the installments within a given timeframe. If you cannot repay a bridge loan in good time, the total amount may not make business sense.
- Need Plan B
If you are unable to get permanent financing before the bridge loan is used up, you need to devise a plan B to avoid running into deeper financial woes. Remember, you could lose the real estate property for not honoring payments. If money issues are looming, and you may not manage to finish the project within the stipulated time frame, a transitional loan is not a feasible option.
- Slashing Real Estate Price
The real estate market is volatile, and things could start on a promising note only to take a downward spiral and remain that way for months on end. As the grace period draws to a close, you may be tempted to slash the listing price of your property to allure more buyers. A price cut usually means selling below market value to meet the obligation of the bridge loan or risk upsetting the lender.
Find a Lender for Commercial Bridge Loan Near Me
Overall, we advise clients to be discerning when seeking commercial bridge loans and over-relying on this option is not a smart move. The high interest may be crippling to an enterprise that is struggling to stay afloat, and if things don't go as planned, the business could tank, and this leads to massive job cuts.
Risk analysts advise business owners to understand the pros and cons of transitional loans before declaring them as the optimal short-term solution. It is paramount that you have a specific, actionable goal in mind before applying for an interim loan and have your partners on the same page.
After all, this stop-gap solution must be appropriately utilized to achieve goals that will propel your enterprise to new heights and not breed financial woes. Contact Money Lender Loans in Orange County at 949-409-4372 for our expert advice on bridge financing for your enterprise.