Bridge Debt vs. Fixed-Rate: The Hidden Costs That Could Crush Your Returns
We keep hearing the argument that it's better to go with bridge debt because it's more flexible and cheaper to exit. One of the best things about real estate is the fact that you can leverage it. This allows a buyer to get into an asset with much less money upfront and helps create larger returns. If it’s done improperly, however, financing creates problems and potentially a total loss.
Multifamily offers various types of loans. The most common type is fixed-rate debt. This type of debt is amortized over a 20-30 year term and is fixed for 5-10 years. It allows you to leverage 65-80% of the purchase price. Another popular type of debt is floating-rate bridge debt. This debt allows you to finance both the purchase and renovation expenses at up to 80% of the total cost. Bridge debt is typically floating rate and interest only.
Is getting a 5-year fixed-rate loan more expensive than a bridge loan?
Let's look at a $25mm mortgage with a sale in year 3.
Case #1: Fannie Mae agency debt with a 5-year fixed and a step-down prepayment. Selling in year 3 will cost about $500,000 in pre-payment penalties. The great thing is if it makes sense to hold for another year or 2, you have maximum flexibility.
What about a 10-year fixed? This one gets us closer, with the pre-payment penalty in year 3 being $1,000,000. Still cheaper than the bridge debt option below.
Case #2: Bridge debt. The term is a 3-year floating with two 1-year extensions. The interest rate cap will cost you around $1mm to $1.5mm. This is a little tricky because it depends on the spread given by the lender, but to match the interest rate by Fannie Mae, you'll need a rate cap of around 2-3%.
Rate Cap calculation on 2/17/2025 by Chatham Financial for a $25mm bridge loan
Now, you could say, why match Agency debt interest rates? Ok, let’s do a rate cap at 4%, which will put your loan around 7% interest. The rate cap only costs $347,000. The issue is that you’ll end up paying about $937,500 in additional interest over 3 years when compared to the Agency loan.
Here's the rub: Draw requests cost money, and closing a bridge loan is more expensive on the purchase. Bridge debt often has an exit fee that can be as high as 1%. These costs add up quickly.
Even worse: With Bridge, if you can't sell in year 3, you need to buy a new rate cap, which will cost around $500,000 for each additional year, plus 0.25% extension fee, plus attorney fees for each year!
✅Fixed rate costs: $500,000 to exit
✅Floating Bridge costs: $1.75mm+ to exit
There are a few reasons why companies use bridge debt:
Distressed asset with a large value add. Companies that are buying properties that cannot qualify for traditional debt may opt to go with bridge debt. In this case, the company is buying an asset for a large discount where there is a large amount of renovation dollars to invest.
A quick bridge. If a company finds a great deal that needs to close quickly, bridge can get them to the closing table, while they wait for permanent debt. This is often used when the buyer wants to use a HUD loan. Hud loans take 6-9 months to close, but most sellers don’t want to wait that long to close. The buyer does a bridge loan, gains ownership, and within 6-9 months refinances with HUD.
Bridge debt is a tool that should be used sparingly, not as your main loan of choice. Purchasing real estate already comes with operational risk. If you add on a renovation/value-add plan, there is even more risk. Now, hitch on Bridge debt, and you are multiplying risk.