In the past week I’ve been presented with three deals that had same story:
Sponsor reaching the end of term on their bridge debt–>attempts to refinance–> proceeds offered from permanent lender fall short of bridge balance. Need cash at close.
To explain this dilemma, here’s the following example. Say you bought an asset for $25M and planned to spend $5M in renovating units at the property. That situation would bring your total capitalization to $30M.
In the past few years, bridge lenders have been offering very high leverage products at very low interest rates to buyers of these assets. Typical loans on such deals were as high as 82% of cost (82% LTC in real estate lingo), totaling about $25,000,000 of loan proceeds.
This bridge debt typically came with a three-year term, which means the lender would expect to be paid back by year three.
When year three comes, the sponsor has two options. Either sell the asset, or refinance with a permanent loan. Either way, the original lender gets their money back.
What has begun to happen is that as sponsors have come to refinance with a permanent loan, their new lenders are falling short of their bridge proceeds, the reason being… rising interest rates. (Rising interest rates force lenders to require higher property-level income in order to increase proceeds, something that we could get into another time.)
So in our example, imagine you attempt to refinance, and your permanent lender provides you a quote for…. $23M.
That is $2M short of what you need to pay your bridge lender back. And if you don’t have that kind of cash to inject into the deal, it means you are down to one option: sell the asset.
This is an important trend to keep track of because it can have many influences on the market.
First of all, it is a trend that will likely become even more common if interest rates go up once again, and it looks like they will. (This article was written on 9/12/2022)
But it causes other issues: owners who are struggling to refinance — especially syndicators who do not have large cash balances available — may be forced to sell in order to get out of deals.
And if that happens across the industry, we may have a situation in which many sellers are forced to sell their assets at the same time. Having too many sellers relative to the buyer pool may force asset prices down quickly, and create a buyer’s market.
For now, my evidence that this trend exists is anecdotal. But if the trend continues, it may change the real estate market as we know it.
Livi Kapital has engaged numerous equity groups who are interested in investing as preferred equity in such scenarios: to help bridge sponsors through the high rate environment.
If you are a lender and have a client who needs equity to close a refinance, please reach out. We’d love to explore.