When possible, raising a bridging loan against commercial property can be one of the quickest ways for a business to access substantial amounts of cash. However bridging loans are pricey and this article discusses how such loans work and the risks involved in taking one.
Commercial property bridging is a small and specialist area of short term lending. Advances are normally based on ‘ninety day’ property valuations where the valuer assumes there is only a restricted period within which to sell the property.
As this is an area where charges are high and it is possible for lenders to make significant profits from defaulting loans, it is an area where you need to be well advised as to your choice of lender.
Pre credit crunch, lenders had often been prepared to lend on the basis of these valuations almost on a ‘non-status’ basis where they did not consider the borrower’s ability to pay. And while the mainstream banks would generally only give a bridging loan where the exit had already been arranged by way of a planned sale or refinancing (a ‘closed’ bridge); other lenders would give ‘open’ bridges secure in the expectation that they would be able to sell the property and ‘collect out’ if needed.
Some lenders were also developing alternative and hybrid products such as a two year ‘super bridge’, and a one year bridge that automatically converted to a normal 15 year term loan at the end of the period assuming that the account has been operated correctly.
The market was however very hard hit during the credit crunch as some lenders’ bank funding lines dried up, while the commercial property values on which they were relying also suffered.
As a result, those lenders that are still in the market are now generally more cautious about establishing both serviceability, the borrower’s ability to pay the interest as they go; and the feasibility of the planned exit from bridging as to how the lender is to be repaid their capital.
However it is noticeable that funds are now returning to this market, and in the absence of the self certification commercial mortgages that had been available pre-credit crunch, bridging is becoming an increasingly important source of funding for both some transactions and raising working capital.
For lenders, the key criteria and issues in lending are firstly the quality of the property and its worth as assessed by a professional valuer on the lender’s panel, followed by the viability of the proposed exit, and then the borrower’s ability to service the borrowings.
The main players in the market lend at up to 70% to 75% of open market value (OMV); reducing to 60% to 65% on second charge loans.
Facilities are usually granted for six or twelve months and are interest only arrangements with the loan capital repayable at the end of the term. Both having your exit in mind at the outset, and checking the provisions in respect of renewal of the facility at the end of the initial term if that should prove necessary, are therefore critical in any open bridge.
Bridging is expensive money. As well as valuation, broker, and legal costs you can expect to pay a lender’s arrangement fee of up to 2% to 3% and discounted interest rates of up to 1.0% to 2.0% per month. If not rolled up to the end of the term, interest is either collected upfront by way of a deduction of the total interest charge for the facility period from the initial draw down, or monthly in advance. Always also check to ensure there is not an exit fee as well at the end of the term.
It’s important to note that the interest rates suggested above are the discounted rates for prompt payment and it is normal for the full rates to be almost double these. This is an absolutely critical point as in the event of default on a payment (such as failing to pay exactly on the due day), you will lose the right to pay interest at the discounted rate and can be charged at the full rate.
All lenders take robust and swift recovery action in the event of default to secure their lending by way of appointing receivers to sell the building. Lenders will also usually have the right to charge administration costs incurred in dealing with any default.
Where the interest on a bridge is deducted from the advance on draw down, this has the advantage that you do not need to find the cash to make payments during the period of the loan. Against this it reduces the funds you actually raise by entering into the bridge and do not forget that at the end of the period, you will need to find the cash to repay the gross amount advanced, not just the net received.
The alternative is to take out a bridge on a pay as you go basis, in which case ensure that you have sufficient funds to make all the payments on time to avoid the increased interest costs and charges that arise on default.
As defaults are an area in which lenders can make extremely high returns, and can recover these by appointing receivers to sell your property, you should take care that you are dealing with a lender you can work with. Brokers will all charge fees for arranging a facility (typically a 2% success fee, deducted from the advance drawn down), but using a reputable broker will assist you in finding a reputable bridging lender.
If you are considering using bridging funding to raise cash for property development, you should also be aware that there are specialist funding products for property development. Again a reputable broker should be able to advise you on the best option for your project.