Has Bridge Financing Cast a Shadow Over Agency Lenders?

With the resilience of the multifamily sector of the commercial real estate industry, alternative financing options have emerged more aggressively than ever, serving more specialized needs, including critical interim financing. Due to recent cap rate compression and pent up funds flow demand in the multifamily space, most multifamily deals trading with significant cash flow constraints with the agencies, namely Fannie Mae and Freddie Mac. As a result, they cannot seem to compete on terms since pricing has become aligned with how aggressive the private debt funds have gotten in recent months and how aggressively priced multifamily deals have become overall.

This is no mere coincidence.

Given these realities, there has been an increase in bridge lending transactions. With more lenders accelerating their bridge lending operations in Q1 and Q2 2021. Across the country, we’re seeing this financial tool become a critical piece of most business plans, providing accretive leverage while allowing the borrower maximum flexibility to make improvements and then transition into permanent financing or sell to move onto the next asset.

Liquidity is Key

2021 is in full swing, with more than $5 trillion in COVID-19 relief infused into the economy since the beginning of Covid in early 2020. These funds including the infusion of the new $1.9 trillion coronavirus relief package is increasing confidence in the economy. It appears that there has been no lack of liquidity in the marketplace. As a result the overall commercial real estate finance market is more liquid than it has been in the past year. On average, cash on balance sheets are at an all-time high for both individual investors and businesses. The increase in the vaccinated population in the US COVID-19 cases have continued to decline and the economy is reopening. This combination is giving industry professionals confidence that the appears that the perceived risk in the lending market is subsiding with more money than ever to deploy.

Requiring Flexibility in Structure

With borrowers looking for flexibility for acquisitions, bridge lenders should be more cooperative and conducive to your business plan than an agency lender. In addition, they should allow flexibility to adapt in a changing market and have the relevant experience to handle future fundings accurately and on time. Granted, not all bridge lenders are created equal – including leverage and pricing and flexible prepayment terms. Agencies typically will only offer up to 65%-70% LTV while some bridge lenders are offering up to 85% LTV with non-recourse.

I have seen an increase in competition from lenders offering bridge programs, with more and more life companies entering the space each month. All lenders—just like all borrowers—are fighting for as much multifamily product as their portfolios allow for, and bridge lending gives lenders a new way to gain market share.

With that competition comes more choices for borrowers, especially in high-growth markets. Bridge lenders are pursuing transactions with increased leverage, minimized pre-pay and lock-out costs; most are non-recourse.

“The bridge space has progressed to a new level of aggressiveness with competition coming from a multitude of sources,” says Jared Stein, director of Arbor Realty Trust. “Bridge opportunities have become so competitive that depending on the market and leverage, we’re seeing bridge loans have tighter rates than some agency long term fixed products, and these bridge loans are, to a large extent, long term (generally 3-5 years with extension options).” With current market conditions and a ton of liquidity still to be deployed, combined with everyone chasing the multifamily asset class, it’s apparent we’ll continue to experience increased volume of bridge originations especially with such tight spreads in the market and very low indexes that are accustomed by bridge lenders—on top of getting the 5-10% more in LTV than you would on an “as-is” agency deal.” Stein concludes.

While the majority of bridge lending goes toward assets in the renovation value-add category, the product is also applicable in new development when a project is in lease-up, some borrowers will take extra time to get the underwritten rents or burn-off concessions prior to entering into a fixed-rate loan. A bridge loan allows them to exit the bank loan and have time to execute the business plan if needed with minimal recourse and maximum flexibility. The primary reason for this is the flexibility around the NOI growth.

If the business plan calls for long-term holds, then life company lenders will offer the most flexibility to convert into permanent financing or offer a structured one-closing loan. If the business plan relies on the value-add/lease-up and sell strategy, it’s important that the lender leverages their loan servicing partner to manage construction draws, due diligence, and insurance.

And it’s important to note that bridge financing is currently offering 3-5 year terms with minor extension options which is basically half of an agency term, which is inherently very appealing to the multifamily industry.

The Impact on Fannie and Freddie

Freddie Mac and Fannie Mae have been lending throughout this COVID-19 pandemic and continue to do so. As government-sponsored entities, they have helped keep the multifamily finance markets exceptionally liquid during this time. Agency debt involves requiring principal and interest reserves, tax and insurance reserves, and replacement reserves for many loans. Agency debt is still quite competitive for higher leveraged loans in the 65-70% LTV range, but other sectors have recently been able to beat them out on most moderate and conservative loan requests. Interest rates in this sector are very aggressive and typically land in the 3.00%–3.75% range.

Freddie Mac has seen a lot of competition from bridge lenders and debt funds, and has reacted by lowering spreads by over 30 bps in the past several weeks.

Fannie Mae has recently started lowering rates, with most loans seeing spreads reduced by as much as 20 bps from this time last month, which has provided some welcome relief as US Treasury rates continue their slow climb.

Bridge Financing Works Best for Value Add Strategies

From a commercial real estate investor standpoint, all concerns aligned with reasons to sit on the sidelines have been squashed. In fact, many such cash-infused investors waiting to get into the game are realizing they have missed the window of opportunity to buy at the “bottom.” Property values have been creeping up gradually on a national basis, and many will agree we are now in a seller’s market. Thus, investors have recently been placing their capital in debt funds to ensure secure risk-profile positions in a commercial real estate market that has experienced lots of sociopolitical volatility.

As far as my own experience from a borrower’s perspective, I have nothing but positive things to say since there isn’t much of a discrepancy in the “all-in rate”. Since I began syndicating multifamily real estate in the form of workforce housing apartment communities in 2017, bridge loan platforms has provided inherent benefits and flexibilities that don’t ordinarily exist elsewhere in capital markets due primarily that we are in a “sellers market”, so the only way to make sense of deals from a creditor standpoint is by factoring in the future growth and proforma. While the legal costs and covenants associated with a bridge loan can be “undesirable”, it can be a very useful and powerful tool to a multifamily owner / operator. And by leveraging bridge loans, my company, Topaz Capital Group LLC, was able to achieve incredible returns to our investors on our value-add multifamily deals, despite the pandemic.

“We’ve seen a significant increase in our bridge–to-agency pipeline in recent months. Our cost of bridge capital remains low and Fannie and Freddie provide up to 80% LTV on the takeout permanent financing. Having one seamless and cost effective execution has been an attractive option for many of our sponsors, particularly those with value add strategies.” said Josh Messier, managing director of LUMENT.

Marc A. Hershberg is the founder of Topaz Capital Group. Prior to that, he was head of Originations and Asset Management at Brick Capital.