If you’re an investor seeking alternative avenues to diversify your portfolio and tap into the potential of real estate, understanding bridge loans can open up a new world of opportunities. Here, we’ll explain what bridge loans are, how they function from an investor’s standpoint, and how you can participate in funds that specialize in this type of private lending.
What Are Bridge Loans?
A bridge loan is a short-term financing tool that covers immediate funding needs until long-term capital becomes accessible. In real estate, it can help borrowers finance purchases, renovate properties, or cover high vacancy rates and transitional periods for properties that don’t qualify or have time for conventional loans.
Terms for commercial property bridge loans typically range from one month to three years, with many around 12 months. Because these loans are short term, a clear exit strategy is critical. As an investor, you can participate by providing the capital, either directly or through investment funds that pool resources to fund these loans.
Why Bridge Loans?
A typical question for investors is: Why do people need bridge loans? While bridge loans typically have higher interest rates compared to traditional financing, they offer unique advantages that make them attractive for certain situations.
The primary benefit is the speed of access to funds, which is crucial for time-sensitive transactions. Bridge loans can be approved and funded much faster than conventional loans, allowing borrowers (who are also investors) to seize opportunities that require immediate action.
Additionally, bridge loans provide flexibility in financing properties that may not qualify for traditional loans due to their condition or occupancy status. This makes them an invaluable tool for investors looking to purchase, renovate, or stabilize properties quickly before exiting to a more conventional loan.
How Bridge Loans Work
Here’s how the process typically works:
- Loan origination: A borrower—such as a property investor—applies for a bridge loan to seize an opportunity. The loan is structured with a short duration and carries higher interest rates to compensate for the increased risk or speed of execution.
- Collateral and security: The loan is secured by the subject property. Should the borrower fail to repay, the lender has the right to claim the property.
- Exit strategy: Borrowers repay the bridge loan upon securing long-term financing or selling the property, enabling the return of the lender’s capital along with interest.
This quick-turnaround financing model is attractive because it often results in higher yields compared to traditional fixed-income assets.
Types of Bridge Loans
1. Residential
- Fix and flip: These are short-term loans used to purchase, renovate, and quickly resell a property for profit. They are ideal for investors looking to capitalize on properties that need some degree of rehabilitation before they can be resold.
- Purchases assistance: These loans help homeowners purchase a new home before selling their current one. They use the equity in the current home to cover the down payment and closing costs for the new purchase.
2. Commercial
- Purchase: These loans provide quick access to capital for purchasing commercial properties. They are often used in time-sensitive acquisitions where traditional financing might take too long.
- Renovations and stabilization: These loans are used to fund renovations and stabilize commercial properties. They provide the necessary resources to complete improvements before securing long-term financing.
- Cash-out refinance: This type of loan allows property owners to tap into their equity and get quick cash for various needs, such as acquiring and rehabilitating distressed assets.
Each category of loan can be first or junior lien position.
Expected Returns From Bridge Loan Investments
Bridge loan investments typically offer returns ranging from 8% to 12% annually, depending on factors such as the borrower’s creditworthiness, the property’s condition, and overall market conditions. There are some bridge loans that can charge more than 12% depending on imbalances in supply and demand factors of the particular loan. These returns are significantly higher than traditional bonds or other fixed-income instruments, making them an attractive option for investors looking for high-yield passive income with shorter capital commitments.
Benefits of Investing in Bridge Loans
Investing in bridge loans can offer several advantages:
- Attractive yields: Due to the short-term, higher-risk nature of bridge loans, interest rates are typically higher, offering the potential for excess returns beyond traditional fixed income.
- Diversification: Adding bridge loan investments to your portfolio can expose you to an asset class that is less correlated with traditional stocks and bonds, and in many cases, even other forms of alternative investments.
- Quick turnover: The short duration of these loans means that your capital can be returned relatively quickly, enabling you to reinvest in new opportunities, if needed.
- Professional underwriting: Funds that specialize in bridge lending often have seasoned professionals who perform rigorous due diligence on borrowers and properties, helping to manage and mitigate risks.
Risks and Considerations
As with any investment, there are risks to be aware of:
- Default risk: Borrowers may default if they cannot secure long-term financing or sell the property. However, these loans are backed by the property as collateral.
- Liquidity issues: Bridge loans are typically illiquid investments. Even when investing through a fund, investors may have longer time periods of commitment.
- Market volatility: Economic fluctuations can affect property values and borrowers’ ability to exit their loans, which in turn can impact investment returns.
How Bridge Loan Risks Compare to Long-Term Debt
Bridge loans generally carry higher default risks compared to long-term financing due to the shorter time frame available for borrowers to implement their exit strategies, as well as the specific risks associated with the property or borrower. Unlike long-term loans that are supported by stable cash flow, bridge loans often depend on factors such as market conditions or property renovations, making them more vulnerable to economic cycles. However, when compared to unsecured loans, these collateral-backed loans—whether bridge or long-term—provide a degree of downside protection.
How to Get Started Investing in Bridge Loan Funds
If you’re ready to explore this asset class, investing in a fund may be the best option. Consider these steps:
- Research investment platforms: Look for funds or platforms that specialize in bridge lending.
- Understand the terms: Familiarize yourself with key terms such as loan-to-value (LTV) ratios, after-repair value, as-is valuation, interest rates, fees, and liquidity.
- Review due diligence processes: Ensure that the fund has robust underwriting and risk management practices. Look for transparency in borrower evaluation and clear exit strategies.
- Assess your risk tolerance: Given the higher risk and potential illiquidity, determine how bridge loans fit into your overall investment strategy. Perform thorough due diligence on all funds you are considering.
To assist you in starting your due diligence, download our guide on how to perform due diligence.
Final Thoughts
Bridge loans represent an exciting opportunity for investors looking to diversify their portfolios with an asset class that offers higher yields and shorter-term capital turnover. If you’re interested in learning more or exploring current opportunities in bridge lending, consider connecting with a reputable platform or investor groups that specialize in this area.
Not sure if bridge loans—or private debt more broadly—are right for you? Take our short Private Debt Suitability Assessment.
About the Author
Brock Freeman serves as the chief operating officer at Kirkland Capital Group, a leading investment fund manager renowned for its principal preservation and superior returns derived from commercial real estate, which he co-founded. As a partner at the Kirkland Family Office, Brock plays a key role in managing and growing family wealth. His professional journey encompasses the fields of technology, finance, and real estate across Asia and America.
In Asia, Brock took on the role of a capital markets analyst and established the sales and marketing department for a software startup. In America, he has assumed diverse roles with mortgage lenders, including loan underwriting and auditing, overseeing teams, and developing mortgage broker origination networks. For a rapidly expanding mortgage lender, he spearheaded a team to develop the industry’s inaugural web-based comprehensive loan underwriting, processing, and secondary marketing platform. His leadership extended to technology teams at Microsoft and TrueBlue.
Brock is a member of the National Small Business Association Leadership Council and an alumnus of the Foster School of Business at the University of Washington. An avid skiing and hiking enthusiast, Brock also has a deep-rooted passion for U.S.-Taiwan relations.
Let’s connect! Follow me on PassivePockets here.