An overview of the rules and mechanics of commercial construction loans
So you’ve reached that point in your business when it’s time for more. Maybe you need to build a larger office to accommodate your administrative staff. Perhaps business is, so you need more sales/display areas. Keeping up with increased demand requires a new production line or workshop. Whatever the specifics, your business needs to expand. Without a doubt, new construction, or even just renovation comes at a hefty cost. Construction projects are expensive, and in the case of renovation, businesses need to worry about revenue lost because of the construction work being done.
Most businesses, especially small ones, can’t afford a brand-new construction project up-front. New buildings or renovations can cost hundreds of thousands, or millions of dollars. Most small businesses simply don’t have that kind of liquid cash on hand. That’s where commercial construction loans come into the picture. In order to make the best of your new construction project, it’s best to understand the financing and mechanics behind a commercial construction loan.
What is a commercial construction loan?
A commercial construction loan is a loan specifically for the building of new buildings, or renovation of existing space.
Often there is confusion between this type of loan and commercial mortgages. A commercial mortgage can be borrowed specifically for the purchase of an already built commercial property.
Who lends commercial construction loans?
The majority of this type of loan is usually given by community and regional banks. These banks understand the local financing and construction market the best, and are thus the best-suited for making intelligent commercial and construction loan decisions. They are also often familiar with the construction contractors, real-estate developers, and commercial developers who will be working on the new project.
National banks, insurance companies, and specialty financiers also offer commercial construction loans as well.
What is the process for getting a loan?
The application process
- Like any other loan, it begins when a developer applies for a loan from a lender.
- After the application, the lender decides whether to go through with the loan. The lender will often make a term sheet with the specifics of the loan. Once this term sheet has been reviewed, negotiated, and agreed-upon, the full underwriting process begins.
During underwriting, the lender will look at risks and details pertaining to the loan. These include things like a huge number of important details.
- Local market conditions
- Financial capacity of the development team
- Borrower/guarantor financial statements and tax returns
- Full project plan
- Engineering specifications
- Much more is often asked of the borrower and guarantor
One of the main differences in underwriting a commercial construction loan and other business loans is the economics and finances. Because this type of loan is for a new construction, there is no past history to underwrite. For example, if a shop needs to expand, it may purchase an existing shopping space next door. Underwriters for the building loan can look at the past profitability of the old business to extrapolate what the future revenue might be of the new acquisition. With new buildings, this is much harder to calculate.
Typically, this process is handled by the attorneys of the lender and borrower. The borrower is also involved in the closing process.
Usually, before the funding can begin, a closing checklist is issued to the developer with a commitment letter. This details what needs to be completed before the loan is closed officially, and funding can begin.
After underwriting, the loan is closed. During this time the loan administration department of the lender is in charge of the dispersal of funds. Some money will be dispersed immediately. Afterwards, money is typically dispersed each month to the borrower. The amount is often based on requests by the developer according to costs incurred.
How can I make sure my loan application will be accepted?
There are a few key areas that can really make or break whether your commercial construction loan application gets closed.
1. A good development team
This is your general contractor, architect, and property manager. Based on their successes and experience, you know the quality of this team.
2. Market demand
Do your research, find out if you the local economy can support a new/larger business.
3. The project is good in the eyes of the local government
You won’t be able to build anything until the city/county/state has given your project the green light. Make sure that your zoning, certifications, and other requirements of the law are sorted out and ready to go.
4. Construction budget
Before you ask for a construction loan, figure out how much you will be spending. If you can bring a concise and accurate construction budget to the table, the rest of the loan process will be much easier.
5. Projection of income
Have a pro forma that lets the lender know how much money you will be making after building. Figure out how much money you will be making when construction is complete. Also figure out how much you will be making for the next few years.
6. Finances of the principals
The principals are those responsible for the loan (the lender). The bank should be worth about 2 times the total loan amount. This is because the biggest risk to the lender is how long it will take the project.
Make the right choice with your business expansion
The commercial construction loan process quickly become an overcomplicated quagmire. With lawyers, numerous documents, and all kinds of variables involved, getting a loan is no easy task. Our team at Reliable Commercial Construction can help ensure you get the money you need for your project. We are an experienced and highly-skilled commercial contractor with a proven track record of success. You will have no problem demonstrating to a bank or lender that we are capable of delivering a project on-time and on-budget. Contact us today and get your project off the ground.