If you have ever done a real estate deal, then you probably have encountered the concept of private-money loans. sometimes called bridge financing, or hard money – even if you elected not to use them to fund your transaction.
Many investors find the idea of using these types of loans, which tend to have higher interest rates and shorter terms than traditional financing, to be highly objectionable. They don’t like the idea of paying those rates or owing money to a party other than a conventional bank. This is a foolish misconception about how real estate works, and it becomes even more obviously foolish when you mention “bridge financing” to the same investors who will not touch a hard-money loan with a ten-foot pole.
Bridge financing is short-term financing and is just private money by another name. Why does it sound so much better to the general population than “private money” or “hard money,” then? Well, because commercial real estate deals often rely on bridge financing when big commercial loans expire. When we go bigger, we tend to assume we are getting something better! The good news in this case is that bridge financing is not just a good way to get your deals done; it is also a great way to generate extremely predictable, highly collateralized investment income.
Here are three things every real estate investor should know about bridge financing but most don’t:
- Bridge financing is for the short-term, not the long-term.
It is important to remember that bridge financing is designed to bridge the gap between your need for capital now and your ability to get better terms or pay off the loan later. This is why it is a great option for fix-and-flip investors, for example. In commercial real estate, investors may use bridge financing to pay a commercial lease while they wait for better terms on a longer-term loan. In residential real estate, the investors call it “hard money” and use bridge financing to pay holding costs and some portion of construction or renovation costs on a property, then pay the whole thing off when the property sells.
- Bridge financing stretches your capital farther.
It is tempting to simply declare, “I’ve never borrowed a dime and never will!” However, this mindset will not grow your portfolio at speed and may permanently delay your ability to scale a real estate business. For example, imagine you have $140,000 to use on renovating a fix-and-flip property in a hot market. Amazingly, you generate not just one, but two leads on really great properties! They are each $80,000, and they will sell for much, much more after you make some fast repairs and upgrades. Unfortunately, if you stick with the anti-bridge-loan mindset, you will only be able to acquire one property because you are just $20,000 short on the second one even before factoring in repairs. However, if you use private money, you can easily acquire both properties and have plenty for repairs. Assuming all goes well, you will certainly have to pay off the loans when you sell but you will have generated far more profit (and kept your capital a bit more diversified) than if you had sunk your entire savings into one property.
- Bridge financing is usually faster than bank loans.
Most real estate investors have a need for speed. After all, they are usually working with motivated sellers or competing with other investors for the deal. Hard-money loans may take days to originate, compared to weeks or months for traditional bank loans.
Bridge Financing is Great from Both Sides of the Equation
Whether you need short-term financing in order to do more real estate deals or you are looking for a way to invest in real estate without picking up a hammer or managing a contractor in the first place, bridge financing is an attractive option. The same things that make this type of financing attractive to real estate investors are the things that make the loan type attractive to investors interested in real estate-related assets. Because bridge financing tends to have relatively low loan-to-value (LTV) ratios, a private-money loan is highly collateralized, very predictable in most cases, and extremely “safe” since a foreclosure will result in ownership of an asset that is easy to liquidate and recoup the costs.
So, don’t write off bridge financing. Whether you want to borrow hard money or become a private lender, it is a great opportunity to help your portfolio grow.