Bridge loan

A "bridge" or "swing" loan is a type of short-term financing that typically has a maturity date ranging anywhere from ninety days to two years. Due to the short exposure period of the loan, lenders are usually able to abbreviate their due diligence and close bridge loans quickly.

Accordingly, bridge loans are most often used in connection with time-sensitive transactions or where complications, such as environmental issues, legal complications, or construction delays or cost overruns, have arisen, and there is both an immediate need for additional capital and a viable near-term exit strategy to pay-off the bridge loan. A bridge loan, in other words, enables a borrower to speedily obtain required capital notwithstanding the existence of issues with the transaction and/or the asset, until such issues are resolved and more permanent financing can be put in place. The price paid for the shorter term of the loan and the quick turn-around by a bridge lender, however, is an extremely high interest rate. For example, while a permanent commercial mortgage might have an interest rate of 7% per annum, it is quite possible that a bridge loan on the same asset would have an interest rate of 18% per annum (or 1.5% per month). In addition, a bridge loan may require the payment of origination and/or exit fees and other expenses which may have to be paid yet again in their entirety upon the closing of the permanent loan a short time later. So, does it ever make sense to incur the additional expense associated with a bridge loan?

Let us assume that (i) ten days prior to the scheduled closing date under a time-of-the essence contract to purchase an investment property, pursuant to which the investor has posted a $2,000,000 deposit, the environmental consultants retained by such investor's proposed first mortgage lender has determined that there may be contaminants located under the property from an underground storage tank that was previously removed improperly, (ii) the long-term first mortgage lender has concluded that they cannot fund the $7,000,000 loan on the existing terms and conditions until a Phase II environmental assessment is completed and the results show no contaminants being present, (iii) the minimum amount of time to complete the Phase II is fifteen days, and if any remediation is necessary, such remediation is likely to take approximately three months to complete, and (iv) the investor cannot obtain an extension of the closing date. In this situation, the investor's most obvious alternatives are to default under the purchase contract, thereby forfeiting both the $2,000,000 deposit and the upside potential of the deal, or closing in a timely fashion but acquiescing to the lender's lower valuation of the property and altering the terms of the long-term financing to include a lower loan-to-value ratio, a higher interest rate, onerous oversight on the Phase II testing, and significant reserves on account of the potential remediation expense. In exchange for electing to put up more equity and close, the investor will be saddled with this loan for a long time, as such loans are typically either not prepayable at all or are only pre-payable after the imposition of a very costly yield maintenance premium.

A bridge loan, however, is another option. Due to the number of times that they extend loans in any given period versus long-term lenders (the same money may be loaned a multiple of two or three times more), a bridge lender is highly proficient at due diligence, and is capable of understanding the transaction in its entirety and the scope of the environmental issue facing the investor before the time-of-the-essence deadline arrives. And, while the interest rate on the bridge loan may be twice that of the long-term financing, the loan is for a short term and is almost always pre-payable (and even when pre-payment is only available with an exit fee, such fees are typically significantly less that a yield maintenance premium).

Most borrowers in dire straits of some sort or another that are not aware of all of the available sources of debt will turn to traditional, long-term, "hard" lenders for bridge loans. Such "hard" lenders are often willing to extend such short-term loans in exchange for the higher rates.

However, mezzanine funds and dedicated bridge lenders are typically able to access their own lines of credit and/or other capital sources and, particularly when an asset's value is not significantly encumbered, charge a lower interest rate than the "hard" lenders for a bridge loan (for example, 11% to 12% vs. 16% to 18%).

"Bridge loan deals," according to Michael Boxer of RCG Longview, a New York mezzanine fund, "have given us the opportunity to help owners avoid the long-term destruction of equity, and allow them the time they need to reposition the property and return it to the market quickly. We have also found that our ability to close quickly has been a differentiating factor

that is truly appreciated by our clients."

In sum, while bridge loans are typically more expensive than market-rate long-term loans, in those instances where there is an opportunity to quickly add value and then refinance, a bridge loan, and especially a less expensive bridge loan from a mezzanine fund or dedicated bridge lender, can enable a property owner to unleash significant long-term value. In such instances there is no doubt that a bridge loan can be extremely cost-effective.