The multifamily market has held up surprisingly well despite the challenges posed by rising interest rates. However, the actual strain comes from the debt piece, particularly bridge loans that many investors took on during the peak buying frenzy in 2021 and 2022. With multifamily properties being heavily bid up, buyers needed more options. They turned to bridge loans, which aligned with value-add business plans and offered higher leverage and lower rates but came with a risk: floating interest rates and short terms.
Why Bridge Loans Became Popular in 2021 and 2022
During 2021 and 2022, the market was competitive. A property that might have been listed at $10 million could end up selling for $20 million after a bidding war. Investors who initially sought traditional agency loans were limited by the lower loan-to-value ratios, often only getting financed by 60–65% of the purchase price. On the other hand, Bridge lenders offered up to 80% financing, which included funds for rehab, making them more attractive despite the floating rate risk and short terms (typically three years).
At the time, the Federal Reserve wasn't signaling any major rate hikes, and buyers assumed they could sell their properties or refinance within 12 months, doubling investor returns. This optimism fueled the surge in bridge loans.
Where Are We Now With Bridge Loans?
As we head into 2024, many of the bridge loans issued in 2021 are coming due. The concern is that values are down by around 30%, and borrowers face refinancing challenges. However, many borrowers are negotiating extensions with lenders instead of triggering a wave of defaults.
For the most part, lenders are willing to work with borrowers rather than take properties back. The consensus is that lenders don't want to foreclose on properties, especially in a market where valuations have dropped. Instead, they offer one-year extensions, often requiring borrowers to buy an interest rate cap and pay an extension fee. This is happening in about 95% of cases. In the remaining 5%, lenders demand significant paydowns or threaten foreclosure.
The Interest Rate Cap Challenge
One of the main hurdles borrowers face is the requirement to purchase interest rate caps. Bridge loans typically have floating rates, and when rates increase—as they have—debt service becomes unaffordable. In 2021, borrowers might have been paying around 3% interest, but today, that rate has jumped to around 8%. Buying an interest rate cap helps to mitigate some of this risk, but caps are expensive, often costing 2–3% of the loan amount.
This has led to capital calls for syndicators. Investors are being asked to put more money into deals to pay down bridge loans to qualify for agency financing or to purchase interest rate caps and extend their loans.
Can Borrowers Refinance With Agency Loans?
Agency loans, such as those from Fannie Mae or Freddie Mac, are still options but come with limitations. The key challenge is debt service coverage ratios (DSCR). Borrowers who initially leveraged with bridge loans at 80% loan-to-value find it difficult to refinance with agency debt, which offers lower leverage—sometimes as low as 55–60%.
Agency loans are still being used for newer acquisitions, especially for higher-quality properties. However, for deals where bridge loans were issued at higher leverage, refinancing remains a challenge due to lower property values and higher interest rates.
Are Banks Taking Properties Back?
Despite some market foreclosures, most banks aren't eager to take properties back. Banks typically only foreclose when a borrower stops making payments, usually when there's no interest rate cap and the borrower can't cover debt service. These foreclosures have happened in major markets like Dallas, Houston, and Atlanta.
However, in most cases, lenders are choosing to extend loans rather than foreclose. They believe that the market will stabilize in the next year or two, making it easier for borrowers to refinance or sell. This belief in the market's potential for recovery is a source of optimism.
What Does the Future Hold?
While the bridge loan issue is far from over, the worst of the crisis may have been delayed. Most borrowers are kicking the can down the road, securing extensions, and hoping for a better market environment in the next 12 months. However, the challenge of rising interest rates, the high cost of interest rate caps, and lower property valuations will continue to create pressure in the market.
Bridge loans remain an issue, but in some cases, lenders and borrowers work together to avoid widespread defaults. The multifamily market, while strained, still has avenues for relief as long as property owners can manage their debt and cash flow effectively.
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