Happening NowGap Funding / Bridge Lending

Evaluating a request to fund a 55k gap behind a senior lender who won't acknowledge a second lien

Take a borrower doing a heavy rehab on a 12 unit in a secondary market. Purchase 640k, budget 210k, senior bridge loan 700k from a private lender, stabilized value the borrower projects at 1.15M with a DSCR refi as the exit. The borrower is 55k short of closing and looking for that gap at 13% plus 2 points, 12 month term, interest accrued and paid at payoff. Reading a senior loan agreement closely in a scenario like this often turns up two problems. One, additional liens on the property require written consent, and a senior lender's officer telling the borrower on a call that they don't do intercreditor agreements on this product means a recorded second is off the table unless that changes, and nothing about a verbal call like that is enforceable. Two, there's frequently no notice provision that helps a gap lender. If the borrower stops paying the senior, nobody is obligated to tell the junior position. That usually surfaces only through a title alert set up in advance. The options in a position like this are limited. Fund unsecured on a personal guarantee from a borrower whose net worth is mostly tied up in this deal and other in-progress projects. Or take a pledge of the borrower's membership interest in the property LLC, which secures the equity rather than the property itself, and needs an attorney to paper properly in that state. The collateral math with a 700k senior against a claimed 1.15M value can look fine on the surface. The real issue is being second in economics with no lien and no information rights, and a 13% coupon rarely compensates for that combination. In cases like this the fix is usually structure before pricing: securing the equity pledge and setting up independent notice, or passing.

wendy_park48 CU1BPRO 17

Answer

marcus_hale41CapitalPRO

The verbal "we don't do intercreditor agreements" is the whole problem and it's fixable in one direction only, by asking the senior in writing and keeping the answer. If they consent to a second with a standstill, you have a real position. If they refuse in writing, you know you're being asked to take equity risk at debt pricing.

On the two structures. An unsecured note with a guarantee from someone whose net worth is three in-progress projects gets you a lawsuit, a judgment, and a line behind whoever else is owed. A pledge of the LLC membership interest is better because a default lets you step into ownership of the entity rather than chasing him personally, but foreclosing on a membership pledge is governed by your state's UCC and LLC statutes and how the operating agreement is written, so an attorney in that state has to draft and review it. Whether it works also depends on whether a change of control in the LLC is itself a default under the senior loan, which it very often is. Read for that clause specifically.

What I'd do with 55k in front of me is separate the two decisions. Decide whether the exit is real using @dpatel_re's refi math, not the 1.15M. Then decide the structure. If the exit is real and you get a membership pledge plus a written obligation on the borrower to forward every senior notice within 48 hours plus a title monitoring alert you pay for yourself, 13% and 2 points is thin but arguable. If the senior won't put anything in writing and you can't verify the refi, the answer isn't a higher rate. There's no coupon that fixes not knowing you're in default until the auction.

marcus_hale41CapitalPRO

4 replies

dpatel_re CP3APRO 22

The stabilized value is doing all the work in this deal and it is the borrower's number. 12 units at what rents, and at what expense ratio? If the refi lender underwrites to a 1.20 DSCR and rates on that product sit where they have been, back into the loan amount that supports and see whether 700k plus your 55k plus accrued interest actually clears. The likely answer is that the exit is tighter than the 1.15M headline suggests, and the whole question changes if the refi only supports 690k. A 210k budget on a heavy rehab of 12 units, with 55k of the closing money already missing, also says there is no contingency line anywhere in this. Ask where the overrun money comes from. If the answer is you, price that.

dpatel_re CP3APRO 22

sonia_alvarez CB4APRO 17

@marcus_hale41's point about change of control being a senior default is the one that gets missed most often, and it means the pledge may be unusable at exactly the moment you need it. @wendy_park48 would he accept a lower loan amount? 55k is what he needs, but funding 40k and making him find 15k elsewhere would tell you something about whether anyone else believes the deal.

sonia_alvarez CB4APRO 17

luis_carrera CS1CPRO 12

Accrued interest paid at payoff means you see nothing for twelve months and the whole return depends on one event happening on time. On 55k at 13% with 2 points that is roughly 7,150 of interest plus 1,100 in points, call it 8,250 on money you cannot touch for a year. Then if the refi slips six months, and refis slip, the accrual keeps building and so does the risk of the senior moving first. A lender in that position usually wants monthly pay on at least part of the balance, even at a lower rate, for the simple reason that it shows you early when he stops paying.

luis_carrera CS1CPRO 12

Reply Anonymous