By Todd McNeill

Rarely do we write these informative blogs to make predictions, but with the recent Fed rate hike, we have been asked by many clients what the future of bridge lending will be. By way of background, nearly all bridge lenders quote a floating rate structure over PRIME or LIBOR to allow for flexibility when it comes time to pay off the mortgage once the business plan has been fulfilled. With these respective indexes trading at historical lows, it has allowed bridge lenders to quote large spreads while still maintaining an attractive coupon to the user of capital based on historic bridge lending parameters. For further background, a bridge loan with very little moving pieces (i.e., stabilized) priced in the low 3% range just 90 days ago for a fully levered request (i.e., 75% Loan to cost). This same deal with significant rehabilitation and or less than break-even coverage on the income/mortgage payment will price around 8% to 9% for an all-in coupon…This was before the Fed instituted its rate hike…

There are currently 70 active bridge lenders in the market with approximately $291 million of unfunded dry powder. This represents a large number of lenders chasing a finite amount of opportunities. Therefore, my prediction is that bridge lending is here to stay; however, bridge lenders will need to adjust their sails in order to compete in a rising interest rate environment. Let’s examine a few adjustments to look for in the near future with this segment of capital.

Spreads – This is the most obvious. Yesterday’s 400 over LIBOR spread will be 300, and yesterday’s 300 spread will be 200. Simply stated, with 70 active bridge lenders there will be fierce competition among this group. Sure, there will be some of the lesser capitalized shops that will ultimately go out of business; however, those that make it will need to compete with price and/or structure in order to win deals. Cap rates have yet to adjust to interest rates, so there are very few deals in the market that are able to absorb these recent rate increases without a reset of property purchase price.

Leverage – Until cap rates move to accommodate yield requirements for today’s leveraged buyer, you may see a period where bridge lenders lower their max leverage to ensure two key metrics for bridge lending underwriting:

1) Exit – Bridge lenders will want to ensure their fully funded bridge loan can be repaid with today’s permanent loan metrics;

2) Debt Coverage – Bridge Lenders will also need to confirm their mortgages can get serviced with property cash flow. Most every bridge lender requires a rate cap as part of the Borrower’s requirements to close, so this is a bit less of an issue than underwriting the exit loan, but it will still be scrutinized.

Warehouse Lines Revisited – We already have been solicited by bridge lenders indicating that they are linking up with cheaper forms of warehouse lines (namely Life Insurance Companies) to lower their all-in cost of capital. This will be advantageous to those that can secure this type of arrangement as it will allow them to earn a nice return on their loans at lower spread premiums.

Creative Structures – We already have seen some bridge lenders roll out unique structures to mitigate rate increases. We recently met with a sophisticated bridge lender that offers a hybrid fixed/float product that allows for the initial funding to be at a fixed rate with each subsequent draw for rehab or re-tenanting costs be subject to a floating rate. This bridge lender has clearly set themselves apart from the market with this product. We may also see some sources quote purely a fixed rate loan with no variability.

Banks – We are starting to see a strong push from FDIC banks wanting to have cash flowing real estate to offset the voluminous construction requests that have traditionally been bank’s “bread and butter.” This we believe has a direct correlation to the banking regulators pushing the banks to diversify away from construction. Nonetheless, banks can be a prime source for flexible bridge loans for safer cash flowing assets whose Sponsors do not wish to encumber the property with fixed rate debt that is not easily pre-payable.

It is always interesting times when rates increase for those of us in Commercial Real Estate Finance. I am thankful that we are not in an environment where the morning papers are indicating that Bear Stearns and Lehman Brothers are going under. This rate hike is in connection with the economy hitting on all cylinders, which is refreshing. Now if cap rates would only follow…

The author, Todd McNeill, is a Principal / Director in the Dallas office of Metropolitan Capital Advisors. Todd can be reached at tmcneill@metcapital.com or at 972-267-0600.