Christian Faes is CEO of Faes & Co.
Many of us have witnessed the increasing appetite for alternative investments. The growth has been substantial, which can be attributed to a number of factors, such as a desire for less volatility and structural changes in the public equities markets.
With this, the ecosystem of alternative investments has broadened, as have the kinds of investors looking for alternatives. This has led to serious interest in real estate bridging finance, as it is an asset class that can provide investors with relatively consistent, stable, asset-backed and superior risk-adjusted returns.
What is bridging finance?
Bridging finance is a short-term loan that is provided to a borrower to bridge the gap in a refinancing event. The term goes by other names, depending on the market, such as “hard money,” residential transition loans or the more generic “private lending.” It is often referred to as “mezz finance,” somewhat of a misnomer because most bridging finance is done on a first-lien basis.
Typical scenarios where bridging finance is used include:
• Allowing the borrower time to find an appropriate tenant and then refinance the loan
• Providing funding to allow the borrower to rehabilitate the property and then sell it for a profit
A critical element in a bridging loan is ensuring the borrower has an exit strategy and that it isn’t a “bridge to nowhere” (or, for the borrower, a foreclosure).
How big is the market?
The numbers are nothing to sniff at, as the residential bridging finance market—in the U.S. alone—has proven itself as a market to watch. In fact, it’s estimated that between 6% and 10% of residential purchases in the U.S. are by “fix and flip” investors. In 2022, there were approximately $130 billion worth of residential real estate transactions that were for short-term investment, and of this, around $45.5 billion was funded through bridging finance.
What are the market’s macro-dynamic drivers?
In the U.S. (as in other parts of the world), there has been an undersupply of new housing stock, while at the same time massive population growth. Furthermore, the average age of residential housing stock across the U.S. is 40 years old. Not only are there not enough houses to meet new demand, but an increasing proportion of existing stock will need to be improved (or rehabbed) to ensure it remains habitable.
Bridging finance has stepped in as a solution, allowing a borrower to purchase a property for rehabilitation purposes, to be sold again for a profit, or to be rented out. This is often referred to as the residential “fix and flip” market, and bridging finance is a key tool for investors active in this space.
Does the banking industry compete?
The nature of bridging finance requires a loan to be provided relatively quickly, a breath of fresh air for borrowers looking to capitalize on a real estate investment opportunity that can be stifled by the arduous process of obtaining a bank loan. Bridging finance also allows the borrower to act as a “cash buyer” and can often negotiate a better deal. Banks just aren’t set up to service a real estate bridging finance customer.
While banks don’t typically compete directly, they do appreciate it is an attractive investment and are active investors in the asset class. Many banks invest in real estate bridging finance, but instead of originating loans themselves, they get exposure by providing warehouse funding lines to originators, investing in securitizations, and investing in the secondary market (after having been originated by a nonbank bridging lender).
What does due diligence look like for the lender?
Just because bridge financing is provided quickly does not mean any shortcuts are taken. It does everything that a bank would do when underwriting a borrower for a traditional mortgage but is unconstrained by the bureaucracy and regulation a traditional bank lender works within.
The process of due diligence on a borrower is broken down into three parts:
Property Assessment
An independent appraisal is obtained from an appraiser who will visit the property and conduct an internal inspection, followed by a comprehensive appraisal (including internal photographs) and an analysis of the property’s value based on comparable sales. Also included is an economic assessment of the local area.
Borrower Assessment
Bridge financiers have the due diligence systems that a traditional bank lender will have, including the ability to do extensive background checks on a borrower, as well as secure three credit reference agency FICO scores.
Borrower Experience Assessment
Depending on the borrower’s plans for the property during the bridging loan term, due diligence is conducted around the borrower’s experience with similar projects. This includes pulling title information on previous transactions to verify experience and that previous projects have been commercially successful.
What are some of the concerns to be aware of with bridging finance?
While bridging finance is a key tool in building the supply of homes in the U.S. and regenerating an aging housing population, there are things that borrowers and investors should be aware of. Not all lenders are the same, and it is important for you to assess where the funding for the loan is ultimately coming from. Some lenders sell their loans to investors after they have been originated, and often, the small print might come with terms and conditions that you need to be aware of. If you’re not sure, then you should always seek advice from an advisor who is experienced with bridging finance and make sure that you’re dealing with a reputable lender.
What is the market’s growth story?
While real estate bridging finance is not new, the institutionalization and growth of the market have been particularly prominent in the last 15 years. Going back several decades, real estate bridging finance was a relatively small cottage industry, with the typical bridging lender an extension of a family office that would lend capital out on an ad hoc basis.
But things have changed dramatically. The market has grown considerably, with some of the largest financial institutions as very active investors. The asset class has also been securitized countless times, with a wide range of investors in those transactions including endowment funds, large pension funds and sovereign wealth funds.
Is bridging finance just an investing ‘fad’?
The resounding answer is no. What I’ve seen from almost two decades of operating in the sector is that there is now a very consistent positive growth pattern, and I believe that bridging finance has a bright future, with borrowers able to capitalize on real estate investment opportunities using bridging finance. In the years ahead, I expect that this asset class will move more toward the mainstream in the alternative investing universe.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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