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Bridge loans can be a helpful tool in certain situations, but it's important to understand how they work and what the potential risks are before using one. Here are four key considerations commercial real estate investors should keep in mind before using bridge financing:

How Are Bridge Loans Typically Used?

Bridge loans are a type of short-term debt instrument that can be used to finance the purchase or rehabilitation of a property before the borrower secures long-term financing. Because of how quickly they can be closed and funded, bridge loans are often used when a borrower is expecting to sell their property within a few years and needs financing for a new purchase in the meantime.

The key feature of a bridge loan is that it allows the borrower to close on a new property quickly. Being able to secure a property without having to wait for the sale of a currently owned property can be a huge advantage for an investor. These loans can also be helpful if you're looking to buy a property before it goes on the market, or really in any scenario where timing is critical.

Another key feature of bridge loans is that they are typically interest-only loans. This means that only the interest on the loan is paid over the duration of the loan term. This can be incredibly useful when the cash flow is tight and conserving capital is of great importance. Still, the idea is to secure permanent financing before having to deal with a balloon payment when the bridge loan matures.

What Are the Risks of Using a Bridge Loan?

A significant risk of using a bridge loan is that an investor could end up owning two properties if the currently owned property doesn't sell as quickly as planned. This could leave an investor with two commercial mortgages to pay, which could be an immense strain on finances if not avoided.

Another risk worth noting is that bridge loans typically have higher interest rates than traditional mortgages. This is because they are considered to be higher-risk loans. If an investor can’t secure a permanent financing solution and pay off the loan in a timely manner, they could end up paying a lot in interest.

Lastly, bridge loans are typically shorter-term loans, which means the loan is meant to be paid off relatively quickly. This could be a problem if a replacement loan isn’t secured, or if other financial issues occur during the loan term.

How Do You Qualify for a Bridge Loan?

The specific eligibility requirements for obtaining bridge financing typically vary depending on the lender, but getting a bridge loan is more or less the same as obtaining any other kind of commercial financing. Much of the same documentation is required (financial statements, rent rolls, schedule of real estate, income and expense statements on the subject property, etc.) — but in most cases, it is the financials of the target property that are of the highest importance to the lender.

Investors should also note that the amount of funding a borrower is eligible to receive is typically determined by a combination of factors including property value, cash flow of the subject property, and the borrower’s net worth. An investor should be able to provide the lender with this information.

Alternatives to Bridge Financing

Hard money loans are a type of short-term financing typically used by investors to purchase and renovate properties. Hard money financing often has higher interest rates than traditional loans, but they can be easier to qualify for. Hard money lenders also tend to be more flexible when it comes to loan terms, putting them on more or less equal footing with their bridge counterparts.

Private money loans are another good option for short-term financing. These loans are typically provided by individuals, rather than banks or other financial institutions. Private money loans tend to have higher interest rates than traditional loans, but they can be much easier to qualify for.

Mezzanine financing is a type of debt vehicle that is typically used to finance the purchase or renovation of commercial real estate. A mezzanine loan is a form of debt financing, structured to increase leverage on an asset through the insertion of a layer of debt between the first mortgage loan and the owner’s equity. This type of financing typically has a higher interest rate than traditional loans, but it can be easier to qualify for.

Final Thoughts

No matter what financing option you choose for your next multifamily investment, be sure to do your research and understand the terms of the loan before signing anything. Bridge loans can be a helpful tool for commercial real estate investors, providing quick access to short-term capital when needed — but there are some important caveats to consider before using one. It is always best to make sure that obtaining bridge financing is the best option for the deal when compared to its alternatives and to have a solid strategy in place to either sell the property before the bridge loan matures or to replace the debt with longer-term financing.