How do commercial construction loans work?

In August 30, 2016

Commercial Construction Loans - how do they work?

Unlike a simple mortgage to purchase an existing building or office condo, commercial construction loans can require multiple types of loans. It’s often a mix of short-term loans to cover different aspects of construction, followed by long-term funding for the mortgage.

What is a commercial construction loan?

The term “construction loan” typically refers to only the short-term loans intended to fund design/build costs, not including final mortgage loans once the project has been completed. Often ranging up to three years in term, a commercial construction loan also might be an interest-only loan lasting until the building has stabilized with an average occupancy rate for its market – something commonly required before permanent funding can be finalized.

More interested in a commercial real estate loan on an existing building? This recent blog post might be helpful: 10 Ways to be a Smarter Commercial Mortgage Applicant. If you aren’t sure which direction best fits your business, speak to a banker at one of our Arizona branches today with no-obligation consultation. We’ll help you understand your options!

Real estate developers are well-acquainted with all forms of commercial construction loans, since they deal with them constantly as a part of their normal business practices, but it’s an area foreign to many business owners.

A bank lender can walk you through the various steps of the underwriting process, including the type of financial paperwork required, how to obtain a proforma from the developer and, if it’s an investment loan for new construction, how to deal with a lack of operating history.

Does the type of lender make a difference?

Commercial construction loans are an especially complicated area of lending with many loan products and packages to consider. These differ based on whether the project is intended to be an owner-occupied building or an investment opportunity.

They also tend to have higher interest rates than permanent funding, due to the level of risk involved.

Partnering with a community or regional bank that understands the market and reputation of local real estate developers can make an incredible difference, while also bringing important relationships and flexible funding opportunities to the table. For a business owner new to commercial construction and related funding, this can make the process far less complicated.

 Because the lender will also need to conduct multiple progress inspections of the project during its build, it’s also important to identify a lender who is located reasonably close to the construction project. New construction loans carry a high degree of risk, so they’ll need to confirm bank dollars are being used to fund the project, and that the loan will result in a completed building worth the invested amount.

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What should you expect?

 When the decision has been made to build, it’s time to think about funding. Without that, nothing else moves forward.

If a real estate developer has already been chosen, they may have lending partners they prefer to work with, although not required. If you have not chosen a developer, however, approaching lenders to get a better idea of funding requirements and referrals to reputable developers they trust is an excellent place to begin.

When you approach a lender, you’ll need general details of your project. Since it’s a preliminary review rather than something triggering a more formal underwriting process, most won’t require tax returns, financial statements and detailed plans, but you will need basic costs for your construction project, along with projections with their underlying assumptions.

If this process results in a green light with a lender who intends to move forward with the loan process, the lender will work closely with the developer and business to compile detailed information about the project and those involved. They will also be able to share an expected time frame for the process, from application to payment.

An organized approach with highly experienced partners contribute to a successful project, so be sure to allow ample time for the due diligence process.

If you’d like more information about the process, and are looking for a lender to help you break ground quickly, Horizon Community Bank specializes in Arizona construction loans near any of its five branches (Mesa, Lake Havasu City, Parker, Quartzite and Fort Mohave). Contact us today to schedule an appointment with an expert!   

 

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