How to Size a Commercial Real Estate Bridge Loan

No single ratio captures every risk in a bridge loan, so lenders run several tests in parallel and let the most conservative one govern. Loan-to-value and loan-to-cost measure basis risk, debt yield measures how the loan performs as a standalone income stream regardless of cap rate assumptions, and debt service coverage measures whether stabilized income can actually pay the debt.

A deal can pass three of the four tests comfortably and still get sized down by the fourth, which is why sizing a request off a single ratio, even a favorable one, tends to set expectations a lender's full underwriting will not support.

As-is loan-to-value compares the loan amount against the property's current, as-is appraised value, typically capped around 65 to 75 percent for bridge loans as an illustration of a common range, lower than a stabilized permanent loan because the collateral value has not yet been improved by the sponsor's plan.

This test tends to govern most heavily on properties with significant deferred maintenance or vacancy, where as-is value is depressed relative to purchase price, since the appraiser has little current income or comparable sale evidence to support a higher as-is number.

Loan-to-cost compares the loan amount against total project cost, purchase price plus renovation budget and soft costs, and it typically governs on deals with a large renovation component relative to the purchase price. A common range is 70 to 80 percent of total cost as an illustration, though the exact number depends on asset class, sponsor strength, and market.

A deal with a modest purchase price but an unusually large renovation budget relative to that price often finds loan-to-cost is the most restrictive test, since the cost basis rises faster than the as-is value the lender is willing to lend against.

Debt yield divides in-place or stabilized NOI by the loan amount, producing a percentage independent of cap rate assumptions, which makes it a favorite stress test for lenders wary of cap rate compression. A common bridge loan debt yield floor is 8 to 10 percent as an illustration.

Because debt yield ignores value entirely, it can cap proceeds well below what an LTV test alone would allow in a lower-cap-rate market, which is exactly the scenario it is designed to catch: a loan that looks well covered on value but thin on actual income.

Debt service coverage ratio divides stabilized NOI by annual debt service, and lenders typically test it under a stressed interest rate, often the current rate plus 100 to 200 basis points as an illustration, to confirm the loan can still be serviced if rates rise before the exit.

A minimum stressed DSCR of 1.15x to 1.25x is a common illustration of a bridge lender's floor, and this test tends to bind hardest on deals with thinner projected stabilized margins, where even a modest rate increase erodes the cushion between income and debt service.

Once each test produces a maximum loan amount, the lowest result is the number that actually governs, regardless of what the other three tests would allow. A sponsor negotiating proceeds should identify which test is binding and focus negotiation there, since arguing about a non-binding test wastes time.

Lenders will sometimes disclose which test is controlling directly, but when they do not, running all four independently, as described above, is the only reliable way for a sponsor to know before the term sheet arrives.

As an illustration, a sponsor is acquiring a property for $10 million with a $2 million renovation budget, total cost $12 million. As-is appraised value is $10.5 million, and stabilized NOI after renovation is projected at $900,000. At 70 percent as-is LTV, the value test allows $7.35 million. At 75 percent loan-to-cost, the cost test allows $9 million. At a 9 percent debt yield floor against the $900,000 stabilized NOI, the debt yield test allows $10 million. Stressed DSCR at 1.2x against an assumed debt service rate produces roughly $9.5 million.

The lowest of these four results, $7.35 million from the as-is LTV test, governs, even though the other three tests would allow considerably more. This is a simplified illustration; actual lender models weight these tests differently and may apply them at different points in the loan term.

Sponsors frequently size a request off the loan-to-cost test alone because it is the most intuitive, then are surprised when the as-is LTV or debt yield test caps proceeds lower once the appraisal comes back. The second mistake is using an unstressed debt service coverage test, ignoring that most lenders add a rate stress before testing coverage.

A third mistake is assuming the governing test stays fixed throughout the loan term; some structures re-test debt yield or DSCR at extension, so a deal that clears sizing at closing can still face a binding constraint later if performance runs behind plan.

Running all four tests with a conservative as-is value estimate, a complete cost budget, and a stressed rate assumption before contacting lenders produces a sizing range close to what an actual term sheet will show, which avoids setting equity expectations around a number the deal cannot support.

Sharing that internal sizing analysis with a lender early in the conversation, rather than waiting to be told the number, also signals a sponsor who understands the deal well enough to be a more efficient counterparty through the rest of underwriting.

H Equities sizes first mortgage bridge loans from $5 million to $50 million using as-is and as-stabilized value, cost, debt yield, and debt service coverage tests together, and structures mezzanine debt, preferred equity, or co-GP equity to fill any remaining gap between senior proceeds and total project cost.