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Having to take out a commercial construction loan is usually a good indicator for a company. It is prepared to expand existing facilities, purchase property for a completely new facility, and to add new space for a specialized type of business. Commercial construction, on the other hand, is one of a company’s most significant investments. It is frequently a financial outlay that exceeds the financial resources of the company and its owners.
What is a Construction Loan?
A construction loan is a form of short-term loan used to finance a new building project. If you want to develop a multi-family home, an apartment building, a high-rise, a commercial office building, or another significant project, you should look into getting a commercial construction loan.
Construction loans are distinct from other types of financing. The majority of loans are designed so that the borrower receives the entire amount requested upfront. The borrower then makes payments over a defined length of time after receiving the loan.
Construction loans, on the other hand, do not provide the borrower with the entire money upfront. Instead, you’ll collaborate with the lender to design a draw timetable. This implies that as your project progresses, the lender will make payments to you. The first draw, for example, may be used to clear and develop the land. The next drawing you get might be when the foundation is laid, then another when the framing is finished, and so on.
Before releasing the next draw, a lender will usually seek certification from an inspector that your project has reached each new milestone. This procedure will be repeated until all milestones have been met and you have been paid in full.
You will only pay interest on the percentage of the loan funds that you have received when you take out a construction loan. As a result, if the entire loan amount is $600,000 but the lender only lends you $150,000, you will be responsible for paying interest on the $150,000.
What should you do after the project is completed and the full payment is due? You could look into a commercial mortgage instead of paying one hefty payment. The property will most likely act as collateral for the mortgage, and you can pay off the commercial construction loan with the lump payment from the mortgage.
How Commercial Construction Loans Work?
Commercial construction loans, unlike most other types of loans, are not paid in one flat sum to the borrower. Instead, the loan is used only after specified project milestones have been met. While the loan is being reviewed, these benchmarks are spelled out in advance as a draw schedule. As a result, payment schedules vary depending on the project and the lender. Some typical markers in the draw timetable include:
- Clear the land and improve it.
- The foundation should be poured.
- The structure should be framed.
- Purchase the necessary equipment.
As each step is accomplished, the loan is drawn in the amounts agreed upon in advance. Before approving a specific loan draw-down, the lender will almost definitely require a professional assessment.
Commercial Construction Loan Process
1. Connect with a lender
To discuss your project and see what funding options are available, contact a hard money lender or a traditional lender.
2. Commercial construction loan underwriting
Following the submission of your loan application, the lender will promptly analyze it internally before deciding whether or not to proceed. The lender examines the project cost, summary predictions, underlying assumptions, and the developers’ background during this examination. If the lender is interested in moving forward with the project, they may give you a loan term sheet. The term sheet usually lays out the loan’s terms and conditions, assuming that all of the information provided is valid and fair. The lender will proceed to complete underwriting and approval of the proposed loan when the term sheet has been examined and accepted.
The lender gathers more specific information about the project during the underwriting procedure. Building plans, general contractor bids, cost predictions, construction timelines, and other documents may be requested by the lender. A lender may also seek the borrowers’ tax returns, financial records, and any other documents that support the loan application.
From an underwriting standpoint, one of the most significant differences between a commercial construction loan and an investment real estate credit is that a construction loan has no operating history to examine. As a result, the property’s worth is solely reliant on the real estate pro forma. The credit approval process is comparable to that of other commercial loans, but due to the increased risks, the development team, general contractor, and market conditions are all scrutinized more thoroughly.
The lender will send you a commitment letter after the loan has been accepted. This is comparable to a term sheet, except it is a legally binding contract rather than a non-binding term sheet.
3. Loan agreement and closing
After you’ve committed, you’ll be given a closing checklist that details exactly what needs to be done before the loan closes and funding can begin. Additional money are distributed based on a draw schedule for the costs incurred in each stage, as previously stated.
Commercial Construction Loan Requirements
1. Personal/ Business Credit and Credit history
The lender will look at the credit history and score of the individual borrower as well as the credit history and debt status of the business. Naturally, not every construction project will be approved by a bank. As a result, the borrower’s personal credit score will be checked first. Remember that commercial building loans are considered “high risk,” and lenders want to balance that risk with low-risk borrowers—which includes people with good credit. The criteria used to determine creditworthiness differ by lender, but in general, a borrower’s credit score should be in the upper 600s to qualify for a loan.
2. Industry Experience and Current Business Profitability
A lender may want to know about your experience in the industry and see precise up-to-date financial figures for the company.
3. A Sizeable Down Payment
As previously stated, most lenders will want a down payment of at least 10%, but in some circumstances as much as 30% or more, of the overall building costs. The lender may charge a lower interest rate if the down payment is higher and hence the risk is lower. The borrower should have secured the down payment from the business’s resources or personal resources such as credit cards or a home equity line of credit before applying for the loan. However, keep in mind that these can result in an increase in business or personal debt, which the lender will look at.
4. Detailed Description of the Construction Plan
A thorough construction plan will be necessary due to the nature of the commercial construction loan. For example, blueprints, specs, and floor plans fall under this category. Suppliers and labor expenses may also be important considerations. Obviously, the project phases (as well as construction progress benchmarks) must be established. The builder you’ve chosen for the project will almost certainly be engaged with it, at least in the final phases of loan application preparation. To avoid future disagreements over when the project should be reviewed, the benchmarks on the way to completion should be explicit and unambiguous. The next installment of the loan will be released if it is approved.
5. Income Tax Returns and Current Profit/Loss Statement
Finally, the lender will want to make sure that the borrower’s personal and corporate taxes are up to date and in order. A current profit and loss account should also be available to show that the company is in good shape as it embarks on its substantial investment in new development.