What is Expensive? - Institutional vs. Private Mortgages
Any borrower would prefer to borrow at low, fixed interest rates from the most aggressive bank or institutional lender. At our affiliate Winter & Company Commercial Real Estate Finance, more than 95% of our day-to-day business is devoted to arranging just those kinds of commercial mortgages. To the amazement of most (including ourselves), these days, most of the deals Winter & Company closes has an interest rate with a 5 in front of it!
Yet when opportunities come the way of real estate investors, they do not always come wrapped up with ribbons, lots of current cash flow, illustrious operating histories and the promise of immediately being able to achieve a standard 1.25 debt service coverage as well as hitting all the usual underwriting benchmarks. Of course, no one wants to pay 12% in a 6% interest rate environment, but if a property is, at present, not producing any cash flow, or if the owner's/buyer's plan is to transition it from point "A" to point "B", a higher-interest, asset-based loan may be the only way to promptly and reliably get it financed.
In order to facilitate lending to commercial real estate professionals with projects that are currently in an embryonic phase, or in situations where they are transitioning a property from one state to another (for example from manufacturing to residential), we have created W Financial, a direct private mortgage lender. W Financial is able to address the other 5% or so of loan requests that come across Winter & Company desks.
Considering the alternatives:
Compared to the prospect of bringing in much more expensive equity partners, paying 12% for a year or so may not look so terrible, especially if the loan is structured to permit payments of interest only. Unless an equity source is also contributing considerable know-how and needed expertise, one may conclude that paying a higher interest rate for a finite period of time is far less of a burden to bear. Why give away a carried interest in your project unless you really need to do so?
Depending upon the scenario, some loans may include an interest reserve to help the owner/developer get through the non cash-flowing part of the project. Compared to the prospect of missing out on a well-priced opportunity that has significant upside once your business plan has been executed, once again, paying 12% or so for a year on an interest-only basis can seem downright thrifty.
Let's look at the Big Picture: In most cases a bridge loan is just the first part of a two-step financing process: (1) Bridge followed by (2) Permanent financing. While banks typically underwrite loans with a focus on the property's current cash flow and the borrower's credit profile, a private lender will consider the deal from a more comprehensive point of view, taking into consideration the market value of the property, the complexity (if applicable) of any construction that may be part of a developer's business plan, and of course, the borrower/developer's track record, level of experience, net worth and liquidity.
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