In the commercial real estate business, money is a huge factor in moving projects from planning stages to finalization. Whether it is for land acquisition and site development, subdivision construction, or underground utility installation -- developers need to access a significant pool of money to successfully move the project through its various phases.
Once a project is completed there will be cash available, but the problem lies in amassing the funding to purchase the commercial real estate; buy, maintain or rent construction equipment; and line up the necessary contractors and subcontractors.
That is where the concept of commercial construction loans comes into play.
What are Commercial Construction Loans?
Commercial construction loans are used for the specific purpose of accessing funding that will be used to finance the costs associated with the purchase of commercial real estate, as well as the construction or renovation of commercial buildings.
These funds are used to cover material and labor costs that are incurred during the purchase, development, construction and reconstruction phases.
A commercial construction loan is different from a commercial mortgage, which is used to purchase an existing commercial property. A loan, on the other hand, can be used to renovate an existing space or to purchase property and construct a new building.
In the case of a mortgage, the entire amount is usually provided upfront and paid back over a set amount of years. With commercial construction loans, the lender maintains the funds and works with the borrower to create a draw schedule, based on project phases.
After each phase is completed, the lender usually completes a site inspection. In this way, only partial amounts of the loan are released as each milestone is hit.
Why are Construction Loans Beneficial to Business Owners?
In most cases, construction costs are likely to be extremely high. Few businesses or commercial contractors have potentially hundreds of thousands or millions of dollars in liquid cash to apply to project needs.
Without access to cash, however, the project will never get off the drawing board. Having a loan available allows the flexibility to expand or complete a project, while the core business maintains the funding necessary to continue operations during the construction and development phases.
Because the loan is paid out in draws, the developer is only obligated to pay interest on those funds which have actually been received, usually until the fund has been completely disbursed.
By that time the borrower should have access to the funding necessary to pay off the principle balance, or convert the balance to a commercial mortgage using the completed project as collateral.
How to Apply for Commercial Construction Loans
Steps in applying for construction loans include:
1.Complete Project Details
Applicants must be prepared to provide the lender with project details including a complete plan with specs and designs. An architect should provide detailed drawings and plans for the completed project.
The anticipated project cost, including estimates for contractors, materials, and other expenses, must be provided as well. This provides an idea of the total amount that will be required, as well as the timeframes for the anticipated draws. A feasibility study might be required by individual lenders to help them determine whether the proposed development will fulfill the borrower’s objectives.
The lender may also work with the American Institute of Architects to verify the schedule of costs and ensure that all construction-related costs are included.
2. Find a Lender
Small business owners who are purchasing or renovating commercial real estate may be eligible for the U.S. Small Business Administration’s (SBA) 504 Loan Program through an approved intermediary lender.
A fixed-rate 504 loan may be used to purchase fixed assets such as land and make specified improvements, usually with a low down payment and favorable interest rates.
If the business does not quality for an SBA loan the next best place to apply is usually through a commercial bank that specializes in business financing in Ohio.
If the business has a low credit score, but there is collateral available, it may be possible to obtain a hard money loan.
3. Submit a business Plan
This provides prospective lenders with an overview of the business and its management team, details about current operations, and future growth and expansion plans.
4. Prepare Financial Statements
Current and projected financial statements will be required to prove stability and ability to pay interest during the construction phases. Depending on the lender, this may include tax returns, profit and loss statements, balance sheets, cash flow analysis, bank statements, and current debt schedules.
This will usually require the involvement of a CPA or accounting firm to provide audited statements for review.
5. Contractor Qualifications
Depending on the anticipated project complexity and size of the loan, the lender may ask for a complete list of contractor qualifications and financial conditions.
This will help to assess whether potential contractors have the liquidity, financial strength and availability to take on and complete the project.
6. Loan Approval and Closing
Forms customarily required for a closing include a note, mortgage or deed of trust, construction-loan agreement and personal guarantees.
At this point lenders may require certificates of insurance listing them as a certificate holder, as well as approved building permits to ensure compliance with local zoning laws and building codes.
Be aware of any requirements for progress payments during the course of the project. At the end of the project, an endorsement must be received from a title company which shows that the completed project is clear of liens.
Requirements for a Commercial Construction Loan
Requirements in finalizing construction loans include:
Interest Rates: Interest rates can fluctuate broadly, depending on the borrower’s credit history and the type of lender. Banks and the Small Business Administration will usually have the lowest available interest rates, but it is wise to apply to several possible sources.
Fees: Applicable fees and fee amounts may vary by lender, but may include processing fees, documentation fees, guarantee fees, project review fees, or fund control fees.
Down Payment: A down payment of 10-30% of the total project cost may be required, using a loan-to-cost calculation.
Credit Score: Lenders will look at business credit scores to determine the likelihood of having the loan repaid.
How a Contractor Can Help With Commercial Construction Loans
Well-established contractors can help you create a construction budget, weighing the costs vs. benefits for different options.
While we are accustomed to working with completed designs, contacting Park Enterprise Construction early in the process will typically uncover opportunities for greater efficiency, thereby reducing your construction investment.
For more information, contact one of our experts!