Do Multifamily Bridge Loans = Subprime Loans?

Do Multifamily Bridge Loans = Subprime Loans?

The Dark Side of Multifamily Bridge Loans: A Closer Look at their Negative Impact on the Real Estate

Multifamily bridge loans gained popularity in the real estate industry as a short-term financing solution for property acquisitions. While these loans offer flexibility and access to capital, in a rising interest rate environment there are growing concerns about their negative impact on the commercial real estate market. This article delves into the darker side of multifamily bridge loans and their implications for both investors and the overall real estate market.

I first considered a bridge loan on an apartment deal located in Oklahoma, back in 2018. At that time bridge lenders were already in the multifamily space, but not extensively and still expanding. They offered higher leverage loans that included rehab costs. The terms were tight as they were still figuring out the multifamily value-add model versus the residential fix n’ flip, value-add model (which moves faster). At that time bridge lenders only offered 1-year terms, and no option existed for an extension. If I needed more than 1 year to refinance, the loan broker’s response was “well the lenders don’t really want to take back the asset” I’m sure if more time is needed, they’ll work with you. His response was not very comforting.

The issue with this particular deal was the high concentration of section-8 tenants. Their leases could take longer than 1 year and delay me from getting inside apartments to execute my renovations and value-add plan. I walked away from the deal and the idea of using a bridge loan for multifamily. I couldn’t get comfortable with the bridge loan and conventional financing was getting expensive. The increased risk of higher leverage and shorter terms reminded me of the adjustable-rate loans that caused the subprime mortgage collapse during the great recession. 

Bridge loans came into the market to fill the gap that conventional financing was creating because values were increasing – fast. Deals were becoming debt service constrained (limited by debt-to-service requirements). Eventually bridge lenders adjusted to longer 2-year terms and allowed for multiple 6-month extensions. This provided extra time (at a cost) for investors to renovate larger apartment complexes, as well as higher leverage for the rehab costs. This new loan product caused values to spike, as it gave investors the debt they needed to pay more to buy properties. So long as they completed renovations and increased value quickly and refinanced before interest rates changed it worked out – until it didn’t.

In March 2022 the Federal Reserve started an astounding set of interest rate hikes, intended to control inflation. By December 2022 the federal funds rate had moved from 0.50% to 4.5%. This caught a majority of investors, businesses and public by surprise. Multifamily owners with bridge loans were trapped by their inability to refinance to cheaper debt. Some faced worse challenges that snowballed into foreclosures.

I see similarities between multifamily bridge loans and subprime loans now. I studied option-arm loans during my time in college and wrote a paper on the subject (2005-2006). When the bottom of the market was falling out in 2007/2008 and I was about to embark on my real estate investing career, I managed to insert myself into a property management position. My work was concentrated in the epicenter of subprime loan territory – the Inland Empire of Southern California. This experience gave me a boots on the ground perspective and a front row seat to the unfolding “Great Recession”. I was seeing through the eyes of others, their painful experiences and with my own eyes the volatile market fluctuations that shocked the world.

Here are 3 reasons why the recent years activity of multifamily bridge loans are similar to the subprime activity that preceded the Great Recession.

1. Artificial Inflation of Property Values: One of the major drawbacks associated with multifamily bridge loans is their potential to artificially inflate property values. The same happened when subprime loans extended the rally in single family homes, prolonging the cycle. Investors often secure these loans to fund renovations and improvements, intending to increase the property’s overall value. However, this practice can lead to a temporary inflation of property prices, distorting true market value and potentially creating a bubble effect
2. Increased Risk of Speculation: Multifamily bridge loans encourage a short-term, speculative mindset among investors. The proliferation of social media created an illusion that anyone can easily make huge sums of money buying multifamily properties. The goal of these loans is often to quickly improve a property, sell or refinance at a higher valuation and repay the bridge loan promptly. This is similar to the subprime loans because many of those loans included mortgage insurance. The idea was to refinance a year or so later at a higher valuation and be able to remove the mortgage insurance and maybe even pull out cash. This speculative approach can lead to a higher level of risk-taking behavior, as investors may prioritize short-term gains over long-term sustainability. This increased risk contributes to market volatility and lower values when interest rates rise.
3. Potential for Over-Leveraging: Multifamily bridge loans involve shorter repayment periods compared to conventional financing options. The pressures to repay these loans quickly lead investors to over-leverage themselves, increasing financial risk. When interest rates spiked, over-leveraged investors face difficult financial obligations, potentially leading to foreclosure. During the Great Recession, subprime borrowers decided to stop paying their increasing mortgage payments after determining their house was not worth what they owed on the loan. Subprime borrowers stopped paying mortgages in masses, causing values to collapse.

Multifamily bridge loans have their place in real estate transactions and are a useful product in the right situation. While multifamily bridge loans offer a quick injection of capital for real estate projects, their negative impact on the market cannot be overlooked and is evolving. From the potential inflation of property values to the financial risks these loans raise valid concerns about their contribution to market instability in these current times. As the real estate industry evolves, investors must carefully weigh the benefits and drawbacks of multifamily bridge loans and be wise in knowing when to use this product for property investments.

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