Taking on a bridge loan can sometimes feel like an act of faith. If you are rehabbing a building, either residential or commercial, with a buyer in mind, and need a bridge loan to complete the repairs you promised, it can be a nerve-wracking time. What happens if the buyer backs out? What if their funding dries out? What if they just get cold feet? Those are the kinds of questions that can keep the rehab pro up at night.
You shouldn’t avoid bridge financing out of fear: it can be a viable solution to your short-term cash flow needs (for example, we recently discussed how a bridge loan can save a struggling restaurant). You just have to make sure you know everything about your buyer beforehand, so that you don’t end up holding the bag. Employing strategies to secure the buyer on the front end can help ensure you’re able to pay off the loan on the back end.
Make Sure Your Potential Buyer Does His Homework Before Accepting His Offer
Securing a buyer requires homework for both parties. Your homework is to make sure your buyer has done theirs. Remember that a hungry home or commercial property buyer might bite off more than he can chew. It’s also wise to confirm that your property is exactly what the buyer wants. If it’s a good match, the deal is pretty much a slam-dunk—the buyer will jump through hoops to get their ideal property.
First off, the buyer needs to be happy with the property itself. In real estate deals, heavy-duty negotiation always revolves around the condition of the property and what the seller is willing to repair or write-off from the sale price for the buyer. Make certain the potential buyer doesn’t have too many complaints. If they do, that’s a sign they’re not truly happy with the property.
Be sure also that your potential buyer has thoroughly researched the area, and is happy with the property and its location. If they don’t like the neighborhood or finds it far removed from other necessities, they may look for another property and back out of your deal. A buyer who talks with neighbors or other commercial tenants is a good sign of someone who is genuinely interested in the location.
Relatedly, can your buyer afford to move into the area? Aside from the property itself and its geographic placement, be sure your buyer has properly researched any applicable area costs such as property taxes, utilities, insurance costs, and commercial zoning fees. It’s critical that your potential buyer can afford the property; it’s equally important that he can afford to move into the area and maintain the associated costs.
Keep the Buyer Happy Through Critical Moments
There are several moments throughout the transaction where the buyer can back out.[2. Solomon Poretsky, “When Can You Back Out of Buying a House?,” SFGate, accessed September 24, 2015, http://homeguides.sfgate.com/can-back-out-buying-house-35157.html.] Remaining engaged with the buyer and their agent through these periods helps you maintain the transaction. Keep in mind that the buyer can back out during the period before you formally accept their offer, then later during any inspection contingencies and financing contingencies. It’s important to keep the lines of communication open with your potential buyer and his agent, addressing all concerns adequately to ensure that he is as interested in buying the property as you are in selling it to him.
Watch for Warning Signs
Even the best-charmed buyer might back out of the deal, leaving you holding the bag on your bridge loan, so it’s important to keep an eye out for warning signs of a soon-to-bail buyer. Some crucial things to watch for include:[3. Investopedia, “Housing Deals That Fall Through,” http://www.investopedia.com/articles/mortgage-real-estate/09/house-contract-falling-through.asp (accessed September 24, 2015)]
These are signs that the buyer may be getting cold feet or is looking elsewhere for a deal. Keep an eye on behavioral changes—they indicate that something might be wrong.
Negotiate Before Your Buyer Backs Out
Let’s assume the worst and your buyer indicates that he wants to back out of the deal. This is, of course, devastating news as you’re relying on him to pay off your bridge loan. Don’t panic, because there are still some things you can do.
The key to any negotiating process is communication, so take a moment to regroup everyone and ensure that both real estate agents are communicating effectively. It’s possible that some information did not translate properly between parties. (The same holds true even if you don’t work through agents). Sit down with all the involved parties and make certain you’re on the same page. Ask the buyer: Why is he considering backing out? What will it take to avoid it? Once you are armed with that information, you can problem-solve together and begin negotiating any concessions that will keep him in the deal.
If you cannot come to reach a common ground, it’s time to get technical. Review your contracts and see what seller recourse you have, if any. It’s possible that contingencies were written into the paperwork to protect you in the event the buyer does back out. If so, fantastic, and if not, you can begin to discuss your situation with your bridge lender and your real estate agent to see if you can avoid having to absorb or default on your bridge loan payments.
While there’s no guarantee your buyer will stay on board even if you comply with all requests, there are steps you can take to prevent this worse-case scenario. The key is keeping your secured buyer happy, so the real estate transaction materializes and the money to pay off your temporary funding exchanges hands.
Socotra Capital has been working with real estate investors in California since 2007. We understand the delicate balance you have to maintain on the bridge between selling and purchasing a property. We specialize in bridge loans and can help you navigate these often-misunderstood waters. It’s on the other side of them that your successful fix-and-flip lies.