Bison Financial Group principal, David Repka, was recently interviewed by a national commercial real estate publication to discuss his views on where the bridge loan lending market is headed in Q3 2022....
Q: What are your predictions for bridge lending going forward?
A: Three unwanted guests: Fear, Uncertainty, and Doubt have crashed the party. The party was fueled by cap rate compression, rising values, and low interest rates. In an effort to calm the fear of the worst price inflation we’ve seen in 40 years the Fed has increased short-term interest rates. Market participants are uncertain whether more rate hikes are on the horizon. There is little doubt that consumer confidence has plummeted as a result. Based on these three market forces bridge lenders will do two key things: reduce their risk exposure by saying no to new lending opportunities or if they say yes, they will say yes only to borrowers with an existing “relationship” or lend at lower leverage levels requiring more Sponsor equity. Sponsors unable to locate additional equity will need to borrow from non-conventional lenders (as opposed to regulated lenders such as banks, credit unions, and insurance companies) at a higher cost of capital.
Q: What will be the biggest changes/trends in bridge lending going forward versus years past?
A: The abrupt and across the board slow down in lending has market participants concerned. Leverage is down and interest rates are up. Sponsors need to quickly re-calibrate to the new market realities.
Q: How will underwriting change on these deals going forward?
A: The best way for a lender to manage risk is to just say no to new lending opportunities. The second way is to limit access to funds to borrowers that are already “in the club” and say no to new borrowers. The third way is to reduce leverage.
Q: What type of properties/deals will bridge lenders target? Why?
A: The Great Recession and the Covid-19 Crisis taught lenders that people gotta live somewhere. This means loans on housing in all its forms will remain the #1 preferred type of loan by bridge and permanent lenders. Self-Storage, Multi-Tenant Industrial, and Medical Office are in the number 2 spot. The Bronze Medal goes to Shopping Centers anchored by market-leading grocery stores (Publix, Kroger, Wegmans, etc.) and/or strong big-box retailers (Walmart, Target, Home Depot) will continue to be targeted. Many conventional lenders are no longer quoting loans secured by office properties, hotels, and land.
Q: What will be the typical bridge loan leverage?
A: First, a quick clarification: a bridge loan is a temporary loan on a property in transition. A borrower chooses a bridge loan because the Net Operating Income (NOI) is not at a place where the borrower wants to lock in permanent financing for 10 or more years. The borrower believes that there is the potential to increase the NOI of a property so they borrow short term with a bridge loan until they can execute a business plan to increase the NOI and then sell or lock in permanent financing down the road. With this in mind, Lenders are increasingly stressing the underwriting of the exit strategy contemplated 24-36 months down the road. They are using lower rent growth assumptions, higher CapEx costs, higher cap rates, and higher debt yield assumptions. All this mathematical gymnastics results in a more pessimistic refinance scenario. Since they perceive that less refinance proceeds are available down the road at refinance time, they are throttling down their leverage: 85% LTC has become 70 to 75% LTC and 75% LTC has become 60 to 65% LTC.
Q: What will be the typical interest rates on these deals?
A: The highest quality properties with the highest quality Sponsors will be able to borrow from conventional lenders at or about the Prime Rate of Interest (4.75% as of this writing). Properties and borrowers that don’t make the cut will need to pay 6 to 9% interest to a non-conventional bridge lender. For properties or Sponsors with challenges, pricing will start at 9-10% with highly challenged properties requiring equity-type returns of 12+% to get lenders interested.
Q: How are bridge lenders reacting to rising rates?
A: More conservative exit underwriting resulting in lower bridge loan proceeds and higher equity investment requirements.
Q: What specific markets will see the most bridge lending going forward? What markets are lenders shying away from? Why?
A: Lenders like markets that continue to show strong employment trends and job growth. Florida, Texas, Georgia, Tennessee, Arizona, Colorado, Utah, and the Carolinas continue to lead the way in employment and job growth. Areas with high taxes and job losses, and population losses are much more difficult to attract lender interest.
Q: What will bridge lenders require from the sponsor? (certain net worth, liquidity, experience, recourse, etc.)
A: The trend we’ve noticed is that bridge lenders are looking to the underwriting guidelines of the refinance market to make their bridge loan requirements. As permanent lenders require a NW of 1 to 2x the loan amount and 10 to 20% post-closing liquidity we see bridge lenders applying the same requirements.