Bridge Loans - Managing Debt in a DST Portfolio: Ep 2

Hello and welcome to Exchange Insights, your resource for 1031 market intelligence and education. This is episode two of our Managing Debt in a DST Portfolio series. Today, we're covering bridge loans, a common but often overlooked risk factor in DST investments.

So, what is a bridge loan? A bridge loan is a short-term financing solution typically used to acquire or stabilize a property. Bridge loans usually have terms of 1 to 3 years, and they're intended to be replaced with permanent financing once the property is stabilized.

In the DST world, sponsors often use bridge loans to acquire properties quickly and bring them to market for 1031 investors. This makes sense from a timing perspective. 1031 investors often have tight timelines, and sponsors need to have inventory ready. Bridge loans allow sponsors to move fast.

The problem is that DSTs cannot refinance. Remember the seven deadly sins: no new loans, no renegotiating loan terms. So if a sponsor acquires a property with a bridge loan and puts it in a DST, they need to pay off that bridge loan before the maturity date, typically by raising enough capital from DST investors to pay down the debt.

So, what happens if the DST doesn't sell out in time? This is the key risk. If the sponsor can't raise enough equity to pay off the bridge loan before it matures, you have a problem. There are several scenarios that can play out.

First, the sponsor could contribute their own capital to pay off the loan. Most reputable sponsors have the financial capacity to step in if needed. This is one of the reasons why sponsor quality matters.

Second, the lender could extend the loan. Bridge loans often have extension options built in, though they may come with additional fees or conditions.

Third, the lender could foreclose on the property. This is the worst-case scenario. If the sponsor can't pay off the loan and the lender won't extend, the property could be foreclosed upon, resulting in significant losses for investors.

Fourth, the DST's reserves could be depleted to make loan payments. If the property's cash flow isn't sufficient to cover the bridge loan payments, the reserves that were set aside for other purposes might be used.

Fifth, a forced sale could occur. If none of the other options work, the sponsor might be forced to sell the property quickly, potentially at a discount, to pay off the loan.

So, what should investors ask during due diligence?

First, ask about the loan structure. Is there a bridge loan? What is the term? When does it mature? What are the extension options?

Second, ask about the raise status. How much equity has been raised? How much is still needed? What is the timeline?

Third, evaluate the sponsor's financial strength. Does the sponsor have the ability to contribute capital if the raise falls short? What is their track record? Have they ever had a deal fail to sell out?

Fourth, understand the contingency plan. What happens if the DST doesn't sell out? What are the sponsor's options? Is there a backup plan?

At Anchor1031, we lead with the risk. We want our clients to understand all the potential downsides before they invest. Bridge loans are not inherently bad. They serve an important purpose in bringing deals to market. But investors need to understand the risks and evaluate them appropriately.

In summary, bridge loans introduce timing risk into DST investments. If the sponsor can't raise enough capital to pay off the bridge loan before maturity, it can lead to negative outcomes for investors. Make sure to ask the right questions and evaluate sponsor quality carefully.

Thanks for watching. In the next episode, we'll cover cross-collateralized loans and why portfolio structure matters. If you'd like to learn more about DSTs, please visit anchor1031.com.