MF Syndicators; Why use a bridge loan, now?

[John Sayers]

I asked a similar question in a FB MF group but many syndicators seemed to shy away from the topic. Maybe more on BP can help educate.

Topic: Using 3yr +1 +1 type bridge loans in stabilized MF deals (say 120U+, basic B w/value add capacity) in the current market (economist are busy guessing) and the refinance risk 2-4 years from now when looking to refi...or even sell.

Any concerns on having a new bridge loan now, and hoping the market will not have an event in the short term that could temporarily dry up financing funds (agency and other) making refi near impossible; or any event that basically makes it hard / impossible to ride the storm as the longer term debt may better afford?

Maybe another way to put it... why are you as a GP/sponsor not concerned on using it with your current stabilized deals? What future financing assumptions are you making, if any, for a tight liquidity event?

I see deals that really don't need it and wonder what I'm missing, or what is not being said. I don't see the LPs getting a better overall deal for the added risk (even if one considers it low risk), but maybe I'm missing something.

I'm currently avoiding the short term debt, as a general rule. Right or wrong. I'll look at them, but if they bring nothing else to the deal with it, why bother?

If this is an existing topic/thread please point me to it. Thanks!

[Brian Burke]

@John Sayers right, wrong, or indifferent there are a few reasons why some sponsors are using bridge debt.  Off the top of my head here are a few and I'm sure other folks can add to this list.

1. To boost investor IRR.

2. To reduce the amount of equity to raise

3. The deal doesn't qualify for agency financing

Breaking these down further, sponsors can juice investor IRR because debt is cheaper than equity (bridge at 5% costs the deal less than equity with an 8% pref). The flip side is it increases risk, both from a current cash flow standpoint and from a take-out standpoint.

Some sponsors struggle to raise equity, so they use bridge loans so they can borrow more and raise less. This is especially relevant in low cap rate markets where debt coverage ratios constrain proceeds to low LTVs. The equity raise is a lot different on a 65% LTV agency loan versus an 80% bridge loan. Sponsors can be shooting themselves in the foot with this thinking, however. Some investors shy away from high LTVs because of the risk so you have to wonder if the sponsor could have raised the larger equity tranche (with low leverage) easier than the smaller tranche (with high leverage).

Some properties don't qualify for agency financing because they haven't been 90% occupied for 90 days. This leaves bridge as a more viable option than perhaps CMBS or recourse bank debt.

As to the take-out risk: Sponsors (and their investors) should be evaluating how much "lift" the value-add improvements bring, both from a cash flow perspective and from a valuation perspective. If the value of the property increases 20% from the improvements, an 80% LTV bridge should be closer to 55%-60% LTV when it comes time to refinance. Even when lending is constrained, properties with that low of an LTV (and likely a high debt coverage ratio) should still find capital in the marketplace. The bigger risk factor might be the overall economy wiping out the gains in the income if job losses increase vacancy rates and bad debt losses. Then it comes down to whether those market dislocations work themselves out during the two maturity extension periods that most bridge debt offers.

There's no doubt that bridge debt introduces additional risk.  It should also help deliver higher returns, and if it does not, there's no reason to use it.  Regardless, both sponsors and investors should ask themselves whether the higher returns are worth the added risk when faced with market uncertainties from multiple angles.  Sometimes that answer is yes, sometimes no.