The Ins and Outs of Commercial Construction Loans
Explaining the commercial construction loan process can be difficult and complicated. This article helps simplify this lending process.
The construction loan process is generally for developers. During the real estate boom, it was far easier for developers to obtain commercial construction loans. After the real estate bust, banks began scaling back on these types of loans due to regulations and restricted trade areas for lending. While regional and community banks still provide the majority of construction financing, commercial construction requires a better understanding of market conditions.
When developing property, a commercial property loan requires two distinct types of loans, which later may be combined into a single loan.
• Short-Term Financing – The first stage of financing helps to provide money for the construction portion of the project. This also includes the leasing phase.
• Long-Term Financing – This can also turn into permanent financing. After the project is complete and the leases reflect the market level of occupancy, a long-term construction loan is the best option.
If a lender combines these two types of loans, it is known as a mini-perm loan. This form of financing allows the borrower to take out the construction loan, but is approved for a shorter duration than traditional permanent financing. The purpose of this type of loan is to pay off the construction loan, which provides the commercial real estate project with an operating history. The project can then be refinanced for a loan on the permanent market.
A traditional loan requires an underwriter to evaluate the construction budget, development team, local market conditions, financial capacity of the guarantors and the inherent loan request. Traditional banks require financial statements, borrower/guarantor tax returns, contingent liabilities for the guarantor(s), a schedule of real estate owned, the proposed project’s construction loan sources and uses, full project plans, cost estimates, engineer specifications and any other requested documents. The process is similar to a residential loan, but with the inherent risk of construction loans, the underwriters’ give further condition to the general constructor, development team and prevailing market conditions.
The benefit of construction development teams using hard money lenders is that they can forgo all of this complicated, tedious paperwork. Hard money lenders do not insure developers, but look at the commercial project’s potential itself. More and more banks are turning down commercial real estate developments, as they feel the market is too risky to finance these types of growing endeavors. Hard money lenders see the need for commercial developments, which help promote economic growth, especially in areas where residential real estate markets are booming.