Permit delays, scheduling snafus, supply chain issues, and contractor disputes…if you haven’t experienced any of these, you haven’t been in commercial real estate construction for long. Even the best-laid plans can go awry, and dealing with those setbacks onsite is bad enough. But if you’re not working with the right lender, you might add a few more problems to your to-do list.
It’s always best to prevent problems from happening in the first place. And while construction and renovation projects will always come with challenges, the right financing from the right lender can save you more headaches down the road. This blog will explore the basics of commercial construction lending, provide some insider tips, and explain how the right lender can be your saving grace in an otherwise challenging industry.
What is a commercial construction loan?
A commercial construction loan is a short-term loan designed for construction companies, developers, or builders to finance the construction or renovation of a commercial building. This loan may also be used by other borrowers as a stop-gap measure while a long-term financing solution is being pursued. Its draw schedule (contractor payment plan) helps pay each contractor and subcontractor on a schedule as their work is completed and can keep your project moving forward.
What can the funds be used for?
The funds can be used for a variety of things, but the most common uses of funds include the following:
Payroll and other operating expenses
Materials
Purchasing land
Land development
Purchasing or leasing new equipment
Renovating an existing commercial real estate property
Cash reserves to assist with competitive bidding processes
Could a commercial construction loan help your business?
You won’t need a commercial construction loan if you’re planning to purchase an existing building and move in as-is. However, if the site requires renovations or you need to build an entirely new space, applying for a commercial construction loan is probably your next step unless you have cash reserves that exceed the estimated costs of a significant construction project.
Of course, even the most carefully budgeted project could hit a major snag anytime. So even if you have enough cash to cover foreseeable expenses, it’s often helpful to partner with a trusted lending partner to mitigate any unpleasant surprises and ensure your building project can be completed free of liens and covenants.
How commercial construction loans work
With most loans, the borrower receives the total amount at closing. Commercial construction loans will release the funds according to a draw schedule that identifies payment distribution at various milestones outlined in the loan documentation. For example, the initial draw might be intended for land purchase, and another draw might happen after the foundation work is completed. Often, an inspector will confirm that a milestone has been reached before releasing more funds.
The draw schedule helps ensure that work is completed on time and that the borrower only pays interest on the funds that have been drawn off the loan. If your loan is for $1 million, but you’ve only received $200,000 to date, you’ll only pay interest on the $200,000. Lenders can also structure your loan to include an interest-only period. Then you can either pay off the principal in one lump sum or receive a commercial mortgage for the property and use the mortgage to pay back the initial construction loan.
Longer-term loan options through the U.S. Small Business Administration (SBA) are also available. But don’t worry — you don’t need to become an expert in all aspects of commercial construction lending. If you work with a highly skilled finance company, they’ll be able to recommend the best type of loan or loans for your business and help guide you through the process.
Is your business eligible for a commercial construction loan?
Not all construction projects are eligible for a commercial construction loan. To determine your eligibility, your lender will consider the nature and scope of the project, the ability to repay the loan, your experience, credit score, business credit score, income, and current debt. You’ll also need to provide your lender with detailed construction plans so they can assess and help you minimize risk.
Common types of commercial construction loans
Finding the right lender is essential, as they will be key to helping your project stay on track and avoiding common commercial construction pitfalls. If you’ve been in commercial construction for some time, you may have had the unfortunate experience of working with a lender who didn’t “speak” construction. At Union Commercial Capital, our funding specialists understand the construction process very well and will help guide you to the right loan to help your business in the short and long term.
SBA CDC/504 or SBA 7(a) Loan Programs
These Small Business Administration loans will fund projects up to $5 million, and it’s a popular choice for borrowers and lenders – expect low down payments and competitive rates.
Bank loans
Rates, repayment terms, and down payment requirements will vary depending on your past and present financial circumstances, the market, and the lender you choose. So don’t make the common assumption that banks are all the same. They’re not, and the service, rates, and relationship that a lender offers you may vary more than you think from one lender to another.
Mezzanine loans
This type of loan can get confusing quickly, but its name holds a few clues. A mezzanine is a floor between two stories that helps connect them. Mezzanine financing is an in-between loan, bridging debt financing and equity financing. It’s secured with stock, so the lender can still safely fund higher-risk projects.
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