Investors often ask for “a bridge loan” when what the project needs is construction financing, and the reverse. Both are short-term, both are secured by real estate, and both are meant to be replaced by something longer. But they are built for different jobs, and choosing the wrong one tends to show up later as a funding gap, a stalled draw or a forced extension.
What a bridge loan is for
A bridge loan finances a property that already exists and already works, or nearly works, while the owner does something that makes it worth more or easier to refinance: finishing a lease-up, completing light renovations, resolving a vacancy, or simply buying quickly before long-term financing can close. The loan is sized mostly on the value of the property today and on a credible plan for what it will be worth when the plan is done.
Most of the money goes out at closing. If there is a renovation budget, it is usually modest relative to the loan and may be held back and released as work is completed. Terms are commonly one to three years, often with extension options tied to performance tests.
What a construction loan is for
A construction loan finances something that does not exist yet, or a renovation so substantial that the finished building is a different asset. It is sized on the total project cost and on the value when complete, and the lender is underwriting the budget, the schedule, the contractor and the sponsor’s ability to finish as much as the land.
Very little money goes out at closing. The borrower typically puts its equity in first, and the loan then funds in stages through draws: the contractor submits what has been completed, an inspector checks the work in the field, title is updated to confirm no new liens, and the lender releases funds for that work. Interest is usually charged only on what has been drawn, often paid from an interest reserve built into the budget.
Side by side
- What is being financed: an existing property (bridge) versus a project still to be built or substantially rebuilt (construction).
- How it is sized: on current value and the business plan (bridge) versus total cost and completed value (construction).
- How it funds: mostly at closing (bridge) versus in draws as work is verified (construction).
- What the lender watches: leasing, rents and the exit (bridge) versus budget, schedule, contractor and change orders (construction).
- How it ends: a sale or refinance into permanent debt in both cases, once the property can carry it.
How to tell which one you need
Ask how much of the money must be spent before the property can earn what the plan assumes. If the answer is “not much, and the property already has income,” the project usually belongs in bridge financing, with a renovation holdback if needed. If the answer is “most of it,” or if permits, a general contractor and a construction schedule are involved, it is a construction loan, whatever it is called on the term sheet.
The gray zone is the heavy value-add deal: an older multifamily property with a large unit renovation program, or a building being converted to a new use. Here the right structure is often a bridge loan with a construction-style draw process for the capital budget. The point is to match how money is released to how risk is actually retired.
“Match how the money is released to how the risk is actually retired.”
Reserves, extensions and the exit
Three details decide whether a short-term loan does its job. Reserves: interest, capital and sometimes leasing reserves set aside at closing so the project is not short of cash midway. Extensions: options to extend the term, and the tests the property must meet to use them. The exit: a realistic view of what permanent lenders will need to see, in occupancy, income and debt service coverage, at the end of the term.
A good short-term loan is underwritten backward from the exit. If the refinance only works at a value or rent that the market has not shown, the structure is wrong, and it is better to find that out before closing than at maturity.
Questions to ask any lender
- How is the loan sized, and what value or cost is it based on?
- How much funds at closing, and how are holdbacks or draws released?
- Who inspects the work, how long does a draw take, and what documents are needed?
- What reserves are required, and what happens if a reserve runs out?
- What are the extension tests and fees?
- What will the exit lender need to see?
For general information only. This is not an offer or commitment to lend, insure or invest, and not legal, tax, accounting or investment advice. Terms, availability and eligibility vary and are subject to credit approval and applicable law. Fortuneo Redux Reinsurance, Ltd. and Fortuneo Manens Life & Annuity Company are planned entities and are not licensed.