Exit strategies are a necessity in both hard money lending and bridge financing. An exit strategy is a plan for paying off a loan on its maturity date. And given that both hard money and bridge loans are typically structured as interest-only loans, the exit strategy needs to be solid. Lenders need to know that borrowers have a way out before they will approve.
It is interesting to note that exit strategies can be trickier with bridge financing. Many of the same exit strategies used for hard money loans also apply to bridge funding. The significant difference is in timing. Get the timing right and everything works out. But get it wrong, and even the best exit strategy can fail.
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Two Main Exit Strategies
Actium Lending, a Utah hard money and bridge lender based in Salt Lake City, says that an exit strategy can be anything lender and borrower agree to. But by and large, there are two main exit strategies fairly common to bridge financing:
- Asset Sale – By definition, bridge loans cover financial gaps. An investor might be trying to buy a new property even while another property is up for sale. Once the second property sells, its proceeds go to pay off the bridge loan.
- Refinancing – Bridge loans are short-term loans. Therefore, a common exit strategy is to refinance with a long-term, more conventional loan. The long-term loan covers both the bridge loan and any additional financing requirements the borrower might have.
The financing strategy only works for value-add properties. A good example is a rental property that needs some minor rehab in order to stabilize it. As long as the rehab takes place and the property starts generating the expected rents, a conventional lender is more likely to offer long-term refinancing.
Two Main Challenges
Bridge financing adds some extra challenges to exiting. There are two in particular, beginning with the secondary transaction. Let us go back to the previous example of buying one property while selling another. It is something Actium Lending is familiar with.
Actium once lent to a regular client who could not pass up the opportunity to purchase a rental in a popular tourist area. The client was also listing another property in his portfolio. But in order to make the deal on the new property, he had to move quickly.
Everything worked out well. The client picked up the new property and sold the existing one. But what if the existing property had not sold prior to the bridge loan’s maturity date? The client would have had to come up with the money in some other way.
The other big challenge is timing. A typical bridge loan has a term of 6-12 months. Hard money loans tend to have terms of up to 24 months. So when applying for bridge funding, a borrower needs to be sure that his timeline is solid. He needs to be sure that the future transaction he is relying on to pay his loan will be completed in time.
Lender Scrutiny Is Expected
Because of the challenges of bridge financing and exit strategies, borrowers should expect lender scrutiny. A hard money lender will expect the borrower to present a clear, documented exit strategy along with a realistic timeline. If there is any doubt in a lender’s mind, a loan probably won’t be approved.
Exit strategies are necessary for both hard money loans and bridge funding. But exits are a bit trickier in the bridge financing space due to timing and secondary transactions. That could explain why hard money loans are more common.
