Commercial Construction Loans
The construction loan process is much different from what you will experience when seeking other types of commercial loans. A commercial construction loan is essentially a bridge loan since it is typically provided for a short term until the property is suitable to meet the qualifications required for permanent financing. The purpose of a commercial construction loan is to fund the costs associated with the construction of commercial real estate. This includes funding the interest on the loan during the construction period and the initial lease-up.
It is common to be offered short term and permanent financing during the construction loan process. There are normally two loans needed to finance a commercial real estate construction project. However, these two loans can be combined into one:
- Short term commercial construction loan - this stage of financing funds the construction and lease-up phase of the project.
- Long term permanent loan - after a project achieves “stabilization” and leases up to the market level of occupancy, the construction loan is “taken out” by a longer term permanent loan.
When construction and permanent financing is offered in combination, the loan is often referred to as a “mini-perm” or a “construction-permanent” loan. In this case, you will receive funding for the project from construction to market stabilization. There are built-in mechanisms in this type of loan structure for the loan to term out or start amortizing on a monthly basis after the construction/stabilization period. This is normally a period between 18 and 24 months. The construction-permanent loan will often amortize on a 20 or 25 year schedule with a balloon payment or maturity 10 to 15 years after it converts to a permanent loan.
Commercial Construction Loan Review and Underwriting Process
After you have submitted your initial commercial construction loan request, a quick internal review process will take place to determine whether to go or not-go forward with a more in-depth analysis. During this quick internal review, focus is given to an examination of a basic outline of the project, the project cost, summary projections with underlying assumptions and the background of the sponsor and project developers.
It is not unusual for a commercial construction loan request to get rejected after a preliminary review. A variety of factors can come into play that will result in the denial of a loan request. One reason is that a lender might currently have several ongoing construction projects in its portfolio and not be in the market for another. Another reason for denial could be that the project is too big or too small and doesn’t fit into current lending parameters.
If a decision is made to move forward with a deeper review of the loan request, a non-binding term sheet will be provided. The term sheet will outline terms and conditions of the proposed loan. At this point, you will have the opportunity as the sponsor to negotiate changes in the term sheet or approve it as-is. Once approval has been given, the loan process will move into the underwriting stage.
During the underwriting stage, an evaluation will be made of the proposed project’s proforma, construction budget, local market conditions, development team, financial capacity of the guarantors and any other risks inherent to the loan request.
These are typical documents that you should be prepared to provide:
- Detailed building plans to include construction timetable
- General contractors’ bids
- Construction cost projections
- Copies of all local, state and federal approvals
- Pre-leasing information
- Three-year financial history of sponsor’s company and all guarantors involved in the project
- Sponsor’s company and personal tax returns
- Financial statements
- Schedule of real estate owned and contingent liabilities for all guarantors
- Proposed project’s proforma
- Construction loan sources and uses
The underwriting process will uncover all the good and bad as it relates to your commercial construction loan request. It is imperative that you provide as much detail information as possible about your project and not misrepresent the facts. If you intentionally leave out, withhold or cover-up information, it will only hurt you and potentially cost you money.
You can expect a detailed financial evaluation/appraisal, a feasibility study, a site environmental test and other project-specific professional reviews to be ordered at your expense. It will be critical that the independent appraisal and market feasibility study validate the value of the finished project and the underlying assumptions that support the project plan. As an example, will lease-up take you longer than originally expected, or will it work out as planned? A longer lease-up period will increase the carrying costs of the construction loan as well as the total cost of the project. Will the market support your projected rent levels? Any of these factors and others can impact the overall cost of your project or the project’s ability to make its debt payments.
The time-frame from submitting your commercial construction loan request to closing can take anywhere from 45 to 90 days. You will receive a commitment letter that provides all the details of the loan and binds you to the financing offer upon your written approval. It is advised that you enlist the services of an attorney proficient in commercial real estate transactions to help you review all lending documentation. Your attorney can provide valuable insight into whether any of the loan requirements set forth in the commitment letter merit further discussion or modification.
Commercial Construction Loan Agreement and Closing
Once the commitment letter is executed, you will be provided with a closing checklist that outlines the due diligence documents you and your attorney must provide prior to closing.
These are the typical documents that are requested:
- A title search of the financed property
- A Uniform Commercial Code (UCC) filing
- A judgment lien and bankruptcy search of the sponsor and any guarantors
- Evidence of insurance covering the financed property (including builder’s risk coverage during the construction period)
- Entity information for any sponsor or guarantor such as bylaws or operating agreements
- Certificates of legal existence, articles of organization and authorizing resolutions
In addition to the above documents, a construction loan agreement will set forth the conditions that must be satisfied prior to the advancement of any needed construction funds that will occur in stages over the course of the construction. Certain conditions will have to be met prior to the initial advance of funds. These conditions are typically provided in the form of evidence of municipal approvals to include a building permit, lender approvals of plans and specifications, and a construction budget and contractor schedule.
There will be additional conditions on advances over the course of the commercial construction loan term. These controls on advances are part of an effort to devise and enforce safeguards against risks that are inherent to construction loans. These include such risks as increased construction costs, weather delays, and unscrupulous or substandard contractors.
You can expect routine inspections by either the loan officer or another of the lender’s agents of all construction work in place prior to approving each advance. The construction loan agreement will also restrict the frequency of advances and set forth the percentage of the cost of the completed work that will be advanced. As such, it is important that the criteria for advances merge with the corresponding provisions set forth in the contract with your general contractor.
Prior to any final disbursement of the balance of loan proceeds, you will need to provide a certificate of completion from the architect, a copy of the certificate of occupancy and an “as built” survey that shows the constructed improvements upon the land. From a financing perspective, the value of the collateral granted as security in a commercial construction loan depends on both the successful completion of the construction and the realization of the projected economic value of the completed project.
A lender will establish certain safe-guards through its structured financing to protect itself from difficulties that may arise during construction such as unsatisfactory work, delays in construction, violation of building codes, failure to administer subcontracts properly and diversion of funds for other purposes. While the safe-guards put in place are reasonable in light of the risks undertaken, they do result in additional burdens placed on you as the sponsor. However, with the assistance of Highrise Investment Group working together with you, the commercial construction loan process can be very manageable and contribute to the successful completion of your project.
Construction Loan Terms
|Eligible Locations:||Real estate projects located throughout the U.S., Canada, Puerto Rico, US-VI, UK and Caribbean|
|Property Types:||Office, retail, industrial, mobile home park, hospitality, golf course, marina, special use, mixed use, multifamily, senior housing, student housing, condominium and STNL|
|Security:||First mortgage lien on the subject property|
|Loan Sizes:||$4 million to $100 million plus (larger loans sizes considered on a limited basis for highly attractive opportunities)|
|LTC:||Up to 90% of cost loans are available for select properties.|
|Recourse:||Recourse and Non-recourse (subject to underwriting) with standard carve out guarantees and completion guarantees
on construction loans
|Closing Time:||45 to 90 days from application and deposit remittance|
|Interest Rate:||Prime and Libor based floating rate|
|Debt Service:||Interest only during the primary term|
|Loan Term:||36 month primary term; with extension options|
|Loan Fee:||1-3% of loan amount|
|Exit Fee:||0% to 2% of loan amount|
|Reserves/Escrows:||Real estate taxes, insurance, replacement reserves, and mortgage interest (as may be required)|
|Underwriting:||Emphasis on equity capital funded in connection with loan, asset quality, value creation business plan,
market analysis, and sponsorship
|Expense Deposit:||$5,000 processing fee (may vary depending on transaction); Expense deposit sufficient to cover third-party, legal
and out-of-pocket expenses
|Third Party Reports:||MAI Appraisal, and Phase I environmental, and other reports as may be relevant and/or required (feasibility, property condition etc.)|