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The dramatic growth in commercial real estate values that peaked in 2007 spurred a wave of development and unquenchable investor demand. As the market cooled, what was a booming real estate market quickly transformed into an ever-growing inventory of distressed properties, foreclosures and seemingly never-ending workout situations.

While many read the headlines and see doom and gloom, savvy investors see opportunity. Given the virtual trickle of appropriately priced deals hitting the marketplace to date, many buyers are vying for each offering. Financing for these projects, however, can be a challenge, as credit is no longer widely available and underwriting standards have tightened. For investors who have identified an opportunity, the ability to obtain financing can be a key factor driving, or limiting, returns on equity.

Short-term bridge financing is most commonly used for the acquisition, renovation and repositioning of in-transition properties. This financing enables the execution of a business plan that brings the property from an “in-transition” state to a “stabilized” state, upon which the borrower seeks to “exit” the bridge loan via a refinance or sale. Bridge loans can take on many forms and vary from conventional short-term financing provided by a local bank to high yield loans.

As distressed properties are typically underperforming with some combination of high vacancy, mismanagement, deferred maintenance and/or undesirable tenancy, the asset in its “as is” state is not one that a lender wishes to own in the case of immediate foreclosure. Therefore, the borrower’s ability to successfully complete the turnaround becomes a critical consideration in the underwriting. Lenders look for a borrower with an established track record of success in similar projects and sufficient management experience.

According to Bob Knakal, Chairman of the New York City-based investment sales firm Massey Knakal, “The key to financing in-transition multifamily properties is the quality of the sponsorship. These properties typically have significant upside potential due to below-market performance or deferred maintenance, and lenders want to know that they are dealing with a sponsor with a proven track record in the local market. Gone are the days when lenders will risk capital on inexperienced investors, particularly relative to in-transition properties.”

Out-of-state investors are having an increasingly difficult time obtaining financing from bridge lenders. Recent servicing data has shown that a significant number of multifamily loan defaults are attributable to investors who did not have previous experience in the local market. Permanent multifamily lenders, such as FNMA, Freddie Mac and FHA, are limiting financing to these investors. Since these government servicing agencies are the primary source of long-term senior debt for apartments, the refinance exit strategy most bridge lenders require is impaired by the very fact that these agencies are viewing out-of-state investors negatively.
According to Sam Pettigrew, a vice president at The Cantrell Company in Dallas, “Sellers are looking for experienced multifamily operators that they believe will be able to handle the asset. Frankly put, they are not agreeing to enter into sales contracts with folks that they do not believe will be financeable at any price.”

For borrowers that are unable to establish the financial strength and credit-worthiness to qualify for conventional financing, high-yield bridge loans may be the only solution. The closing timeframe is typically shorter than a bank loan, and the underwriting process is less complicated. Due to the lower levels of regulation on this type of lender, it is important to conduct thorough due diligence before providing the lender with any deposits for fees and costs. Many borrowers have fallen victim to fraudulent or deceptive practices and lost considerable upfront fees to “pretend lenders.”

The complexity of bridge financing can be challenging for borrowers, particularly in a landscape of changing underwriting standards and fluctuating real estate values. Banks that are still lending are not offering credit as widely as they had been in the past, and loan officers are inundated with loan requests. A poorly presented financing request will get turned down right away, and the chances of a second look are slim. Professional guidance from reputable industry insiders is becoming an increasingly important tool in this fractured marketplace. While opportunities exist for real estate investors who look, bridge financing is no longer as simple as going to the local bank and filling out an application. Bridge financing is a challenging and complex beast, but the rewards are well worth it in a market where buyers can no longer expect to simply buy, hold and ride the wave.

— Adam Luysterborghs is managing principal at Avant Capital Partners.

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