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Commercial
Construction Loans
Effective construction lending on commercial properties combines several disciplines. A property needs to be evaluated on its merits as an existing building before it can be analyzed as a construction project. The key issue to determine is whether the finished product can generate sufficient income to repay the loan used to build, and then "take out" the construction loan.
Successful commercial construction loans rely on five important factors:
- The total costs to build the property,
- The amount of equity invested on the part of the borrower(s),
- The financial strength of the borrowers,
- The value of the property today as if were already completed, and
- The expected annual income the property will generate.
Each of the factors serves as a potential limit on the funds that can be borrowed to build the proposed project.
Determining The Construction Loan Amount
Unfortunately, the key factors listed above are not the only things that can affect the ultimate construction loan amount. Several other things can influence the "loan to costs" factor, for example:
- If you use institutional, government sponsored, or private financing.
- Whether the project is for investment or an owner-user.
- Is the project multi-family or commercial in nature.
Depending upon the answers to those questions, you may be able to borrow up to 90% of the total costs of the project if it is commercial and owner-user in nature. You could conceivably borrower 96% of the total costs of a project if it is multifamily and you are borrowing at least $3,000,000.
However, in today's more conservative lending environment, if you're involved in a commercial project, such as a retail or office building, you may only be able to obtain 70% to 85% of the costs as a loan, provided your loan amount doesn't exceed 70% to 75% of the completed value. This means the developer would need 15% to 30% of the project cost to be cash or equity ... and there are guidelines as to what is considered real equity.
Some lenders might consider a portion of that equity to be in the form of a subordinated second trust deed, but that is more the exception than the rule. As you can see, real property construction is a complex process and your financing partner needs to have real experience in this specialized area of lending.
Interest Reserves
Construction loans are designed to be "self servicing" during the term. This is accomplished by setting aside some of the loan proceeds as an interest reserve. Funds from the reserve are withdrawn each month to make the payment due.
With institutional financing, interest is only charged on the amount of money actually drawn to pay for construction costs to date in any given month. This is not true when using private money sources. They charge interest on the full amount of the loan, used or not, from the date the loan is funded (referred to as "double-dutch" interest).
Recourse and Construction Lender Types
Construction loans are usually full recourse during the construction term because the only source of repayment other than the "take-out" permanent loan is the borrower.
Construction loans are unique in that the value of the property today has little bearing on the loan process, with the exception of helping to establish the existing equity. Sometimes a lender will finance up to 100% of the total costs of the project if the developer has significant experience and there is sufficient value in the finished product. However, that is an exception.
And, although private money financing costs more compared to institutional sources, private money can often save the developer from having to split his profit with an investor-partner. Sometimes the more expensive financing option can actually save you money on the overall project.
If you have a specific project for which you'd like to get financing, please complete our quote form and we will call you to discuss your options:
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