Gap Financing in Commercial Real Estate
Terrydale Capital
Jun 21, 2024 6 Min read
The world of commercial real estate can be a lucrative one, but it also requires significant capital. This is where gap financing comes in, acting as a vital tool for investors to connect the gap between their available funds and the total project cost.
What is Gap Financing?
In simpler terms, gap financing is a type of funding that fills the void between the amount a traditional lender is willing to provide (typically through a senior loan) and the total cost of acquiring, developing, or rehabilitating a commercial property. This gap arises when the loan-to-value (LTV) ratio, which reflects the amount of money a lender is willing to give relative to the property's value, isn't high enough to cover everything.
Why Use Gap Financing?
There are several reasons why an investor might choose to utilize gap financing for their commercial real estate project:
- Unlocking Bigger Deals: Traditional lenders often have limitations on how much they'll lend based on the property's value. Gap financing allows investors to pursue larger, potentially more profitable ventures that might otherwise be out of reach.
- Flexibility: Compared to traditional loans, gap financing can offer more flexible terms. This can include customized repayment schedules, interest rates, and even profit-sharing agreements tailored to the specific project's needs.
- Speeding Up the Process: In a competitive market, time is of the essence. Gap financing can help investors close deals quicker by providing the additional funds needed to secure the property before another buyer steps in.
- Strategic Use of Equity: By utilizing gap financing, investors can maintain a healthy amount of equity in the project. This can be beneficial for various reasons, such as attracting additional investors or securing better loan terms in the future.
Things to Consider
While gap financing offers undeniable advantages, it's important to be aware of the potential drawbacks:
- Higher Costs: Gap financing typically comes with higher interest rates and fees compared to traditional loans due to the increased risk for the lender.
- Investor Scrutiny: Securing gap financing often involves a more rigorous evaluation process for the investor and the project itself.
How Lenders Are Considering Deals
After spending time with our catalog of verified mezzanine and 2nd position lenders actively lending, we have been given crucial insight to how lenders are approaching deals requiring gap financing.
- Deal Size: Many second position lenders, especially those dealing in mezzanine debt, are only entertaining larger deals requiring around $5MM in financing with some having a floor of $2MM.
- Debt Yield: For underwriting purposes, many lenders are requiring an 8% minimum on deals needing gap financing. This is one of the most important factors that lenders are taking into consideration.
- DSCR Requirements: Many 2nd position and mezzanine lenders are basing their underwriting off of a 1.05 - 1.15 DSCR.
- Property Stability: Lenders offering gap financing are being highly stringent on the level of stability of properties requiring higher stability levels, while also taking Pro-Formas into consideration.
Conclusion
Gap financing can be a powerful tool for savvy commercial real estate investors. By understanding how it works and the situations where it might be beneficial, investors can unlock exciting opportunities and propel their ventures forward. At Terrydale Capital, we are staying up to date with our large catalog of lenders offering second position and mezzanine options for gap financing inquiries. As we see these unique financing situations continue to rise across the nation, it is important for investors to stay on top of the requirements as well. Gap financing may not be perfect for all situations and some deals may need broad restructuring, but when you need the right financing for your commercial real estate venture, contact us today!
Partner With Terrydale Capital for Your Debt Financing Needs
When it comes to debt financing, understanding the right timing, process, and options is crucial. At Terrydale Capital, we provide a comprehensive range of commercial loan solutions tailored to meet your business's unique needs.
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Headquartered in Dallas, Texas, Terrydale Capital is a leader in commercial real estate financing. We have close relationships with the nation’s top banks, lenders & family offices allowing us to provide the most competitive financing solutions in the market.
