Why Use a Bridge Loan For Your 1031 Exchange
The prospect of using bridge financing when acquiring a replacement property for your 1031 Exchange may seem counter intuitive for several reasons:
- You may be purchasing a stabilized property that easily meets Bank underwriting requirements
- Most 1031 Exchanges must deploy significant cash resulting in a low leverage loan which is easily financed
- Exchange properties are usually held long term, so locking in a low rate for an extended timeframe is smart
BUT, there are times when a Bridge Loan is actually a better solution to finance your 1031 Exchange….
BRIDGE LOANS & QUICK CLOSINGS – With banks still working remotely and thus moving slower than normal, deadlines to close on a 1031 Exchange can become an issue. Closing with a reliable bridge lender allows you to get to the closing table before your 1031 deadline.
Value Add Opportunity – Maybe you are selling a stabilized asset and want to Exchange into a ‘Value Add’ or distressed property. Using a Bridge Loan will allow you time to renovate and stabilize the new asset so you can refinance based on the newly created value of the asset without the cost of expensive prepayment penalties.
Equity Recapture – In an effort to deploy 100% of your 1031 Exchange, you may wind up having more cash equity in the Exchange property than you want. When using a short-term bridge loan for your acquisition, you can refinance shortly after because there are no pre-payment penalties. Your refinance can then recapture some equity that was trapped in the transaction during the purchase.
Bridge Lending Case Study – A client approached us concerned that his lender would not be able to close before his 1031 Exchange period expired. He was under contract to purchase a newly constructed triple net corporate leased Starbucks with a ten-year lease. The benefits of a Bridge Loan were:
- Closing within 3 weeks, before the exchange window expired
- A loan amount representing 34% of the purchase price, allowing the Borrower to deploy 100% of his 1031 Exchange proceeds
- The Borrower then refinanced the Starbucks at 75% of the purchase price two months after closing without any pre-payment penalties or minimum interest requirements
- The refinance allowed the Borrower to recapture some of the cash equity deployed for the initial (1031) acquisition
In this case, even if his bank had been able to close on time, the Borrower would have had to choose between being underleveraged with a loan amount of 34% of the purchase price or not deploying 100% of the 1031 Exchange proceeds. By using a bridge loan for the purchase, the Borrower was able to deploy 100% of the proceeds and then refinance to recapture equity. A bridge loan for your 1031 Exchange may not always be the best solution, but it is an important tool to have on hand for special circumstances.
Kyle Altenau is the Vice President of Progress Direct, a direct bridge lender providing real estate owners and investors with short term solutions to their capital needs. Progress Direct specializes in providing financing for transactions that require quick closings or other situations where more traditional financing options may not be available.