Bridge Debt vs. Agency Lending
Whether you are an investor needing faster access to cash, refinance a property, or purchase a new one, loans are a necessity. We will look at two loans, one being a bridge loan, and the other an agency loan. Although these loans are used to reach different objectives, both are very popular among multi-family investors and should be reviewed when passively investing.
Bridge loan is defined as a “short-term loan that is used until a person or company secures permanent financing or removes an existing obligation.” As its name signifies, borrowers often use this loan to bridge the gap between starting and completing a task. These tasks might include improving the property’s appeal or finding new tenants, which all lead to stabilization of the property. Stabilization will be vital to the success of a refinance. Stabilization in multifamily is considered 90% occupied.
The improvement and stabilization of the property will also increase its value, so those who plan to sell the property in a shorter period find this type of loan attractive as well.
A bridge loan’s major draw comes in its lack of structure. While agency lenders will typically only approve stabilized assets, bridge lenders make their money on value-added projects that sit in the pre-stabilization phase. If an investor has a strong strategy to increase revenues on an asset, they have an opportunity to produce outsized returns. The bridge loan was created for these types of investors.
Bridge loans also have a quick closing process because they are based on the value of the property rather than the income a property generates. Thus, no need for heavy analysis and the grueling time that goes with it. Additionally, bridge loans offer higher leverage points, decreasing the amount of equity needed to close, and increasing equity multiples created from appreciation. Finally, like agency loans, bridge loans are non-recourse, so investors do not have to risk personal assets.
Challenges of a Bridge Loan
Bridge loans have a short timeline, with a payoff date of less than 3 years. With short-term comes high-interest rates, so these loans tend to be more expensive. Due to its short-term state, there is a higher level of risk involved as well because borrowers must either refinance or sell by the end of the period.
Long-Term Agency Financing
Agency loans are provided by two government-sponsored enterprises commonly known as Freddie Mac and Fannie Mae. These agencies came to existence for the purpose of providing a reliable and affordable supply of mortgage funds.
The agencies consist of mortgage investors who purchase mortgages from lenders and then package these loans into mortgage-backed securities for sale to investors on the secondary mortgage market. Fannie Mae and Freddie Mac offer a wide pool of financing products.
The main draw of an agency loan comes in the form of low-interest rates. Because these loans are long-term, and are typically only approved for stabilized assets, they are considered low risk to those who invest in the notes on the back end. For this reason, lenders can offer more attractive interest rates, reducing a borrower’s yearly debt constraint.
Agencies also offer a sort of hybrid product in the form of floating rate loans that look to add a bit more flexibility. These loans have interest rates that go up and down in parallel to the Secured Overnight Financing Rate (SOFR). Though interest volatility adds more stress to an investment, rate caps are offered to mitigate the risk. These floating debt products are typically 7-10 year term loans with a prepayment of 1% providing flexibility for the borrower by allowing a sale at any date prior to maturity.
Challenges of Agency Loans
Unlike bridge loans, agency loans require a great deal of qualifications. These include strong financials, experience in managing similar projects, and credit scores starting around 660. Also, the borrower must have a net worth of at least 100% of the loan amount with the liquidity of 10% of the loan amount. Furthermore, the property must be stabilized, sitting at 90% occupancy for 90 days. Finally, receiving approval is a long time coming with agency loans, usually taking anywhere from 6 to 12 months.
Although the loans provided by Fannie Mae and Freddie Mac have many requirements, agency loans are a great choice for investors who need to refinance or purchase a stabilized property for a long-term hold. Bridge loans on the other hand offer an alternative option for investments that do not fit within the constraints outlined by these agencies, offering a speedy process and quick access to funds. Both loan products are viable options for investors, and as usual provide key advantages for different situations.
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