Commercial Construction Loans – How To Get Construction Lending

Commercial Construction Loans

A commercial construction loan is a sum of money that is lent to a company that plans to construct a building and a business on a given site. Many companies that build strip malls, residential apartments and condos, and mixed-use buildings need to obtain a commercial construction loan to fund the construction – which can often be a lengthy process.

These loans can often be risky for banks and difficult to obtain. Yet, if you understand the risks involved and the application process, you shouldn’t encounter any major surprises.

1. What is a Commercial Construction Loan?

Commercial construction loans are generally loans that are submitted through a local bank, insurance company or finance institution that specializes in such loans.

These institutions generally have a solid grasp of the local markets and can analyze a company’s financial situation as well as the value of the land. The land value can be difficult to analyze because there are generally no businesses on the land prior to the loan. Thus, the bank needs to look at other factors to determine if the investment is sound.

The bank might analyze other businesses in the area as well as the profits and losses for those businesses. Usually, the bank will look at other businesses in the loan applicant’s category of work to determine the likelihood of profitability. The business will need to go through the loan process (described below). If the prospects seem reasonable to the bank, the loan can then move forward.

2. Who needs a Commercial Construction Loan?

Any commercial company that needs to borrow money to build on a site that does not have a current structure will need to seek out a commercial construction loan. This loan may cover costs that include cost of the land, cost of building supplies and cost of construction.

Generally, commercial companies that do not qualify for an investment real estate loan will seek out a commercial construction loan.

The commercial construction loan process can differ significantly from the investment real estate loan process because the bank does not have any previous information to take into account when making the decision.

The bank needs to make a decision regarding the loan based on something called the real estate pro forma, which is simply a projection of the expected income of the business. This is similar to a business plan, yet the real estate pro forma estimates how much revenue the property can attract.

A commercial loan has added risks for the bank providing the loan. Many factors can affect the repayment of the loan, such as added construction costs, delays and unforeseen issues in the business. The business may not see a profit in several years because of these factors.

Therefore, the bank must look at all angles of the process. The bank might look into the company’s contractor, building team and business team before making a decision. The past, present and future conditions of the business’s market will definitely be analyzed before a decision can be made.

3. How to Obtain a Commercial Construction Loan

The process to obtain a commercial construction loan can be lengthy but efficient. The first step is for the company to fill out and submit a loan through a bank that offers commercial construction loans. Various bank executives will look at the loan and go over the application. The bank will then internally give a yes or no answer.

The bank manager may then look over other factors to determine the risks of the loan and the stability of the company’s market. If the loan looks good, the bank manager will approve the initial application.

The bank’s underwriter will then set the terms of the loan in writing. These are simply preliminary terms that the company can look over to ensure the terms meet with the company’s expectations.

The company applying for the loan reviews the bank terms. If everything looks good, the company can then sign the terms and approve the loan on its end. This is not a binding contract, yet it sets the stage for the full deal.

The bank underwriter draws up the full and official loan agreement with terms to submit to the company. The company looks over the final agreement and signs it. This contract is the binding contract.

Once both parties have signed the contract, the agreement terms begin. The loan administrator funds the loan to the terms and agreements. Construction can finally begin, and the company can begin making payments as agreed upon in the contract.

4. Commercial Construction Loan Terms

Generally, there are two types of commercial construction loan terms: Short-term financing and long-term financing.

Short-term financing is available to a company before a certain point in a project. It can be up until the project is finished or up until the project has reached a certain point. This is generally a point in the project before the construction is complete and before the building is “open for business.” A short-term loan can be available for merely part of the project as well.

Long-term financing is available to companies that want to begin repaying the loan after the project is finished. This can either be once units begin renting within the structure or once the project has reached a maturation date agreed upon by the bank and the company in the original agreement.

A less common type of construction loan is the mini perm loan. This type of loan is a combination of short-term and long-term financing and can assist a company in refinancing and create an operating history.

5. Commercial Construction Loan Requirements

Since construction loans can be very risky for banks, the terms may be much stricter than most commercial loans. Some of the requirements needed to secure the loan include asking the company to contribute a minimum percentage of the costs for construction (often 20 to 30 percent of the total cost).

The bank may also need other information, like copies of the company’s tax returns and other financial documents. Companies should also plan to submit lists of current real estate holdings and the financial information for these holdings. The bank may also ask for a copy of the company’s pro forma or business plan for the construction project.

A company is more likely to be approved if a guarantor is included in the project. Like other loans, the company also needs to submit forms that include the projected costs of the project. The bank may ask to see specific plans, including engineering plans. Often, banks will contact the contractor of the project to assess the scope of the project.

Fees to Expect When Financing Your Commercial Loan

Credit Report

Lenders usually request a copy of your credit report to review your credit history and ultimately determine if they should risk lending your money.

Appraisal

Since the commercial appraisal process requires a certain level of knowledge and experience with a particular type of property and market area, lenders will typically only accept appraisals from one of their tested and approved partners.

Environmental Report

Since the commercial appraisal process requires a certain level of knowledge and experience with a particular type of property and market area, lenders will typically only accept appraisals from one of their tested and approved partners.

Building Inspection Report

This is usually paid before closing as well.

Buyer’s Attorney Fee (Not required in all states)

This fee is paid to the attorney who prepares and reviews all of the closing documents on your behalf.

Closing Fees

The other expenses involved in the financing of a commercial transaction are closing costs. These are due at the time of funding of the loan and can be included in the financing. These costs are usually the origination fee, property insurance, title insurance and title related expenses, property insurance, and escrows for property taxes.

Commercial Property Insurance

This cost protects you and the lender if there is ever any damage to your property. The cost range from state to state and depends on the value of the property.

Legal Fee for Lender

Lenders can require the borrower to cover reasonable legal fees and costs needed by the lender in order to complete funding. This fee amount ranges depending on loan size and details of the loan and/or property.

Title Insurance

This fee is associated with loan policy, loan endorsements, and settlement fees. This generally protects the lender from liability with inadequately performed lien or title searches.

FICO vs. Fakes: Are You Getting the Wrong Credit Score?

If you’ve applied for a loan recently and had your credit score pulled, chances are you are aware that you have more than one credit score. FICO issues a score, and each of the three major credit bureaus also offers its own credit score, too.

Knowing your credit score is important for wise financial management. But you should understand which credit scores are “real” and which are “fake.”

What Is a FICO Score?

This is the credit score most lenders use to determine your creditworthiness. The FICO score comes from the Fair Isaac Company, which has developed an algorithm to determine your creditworthiness using information contained in your credit reports from the three major credit bureaus (Equifax, TransUnion, and Experian).

Lenders and others buy access to the algorithm. Fair Isaac offers different credit scores that emphasize specific borrowing behaviors, such as varying weights for different actions like buying a home or buying a car.

Your FICO scores from each of the three different credit bureaus are different, too. FICO’s formula is applied to the information in each of your credit reports, and since your information may not be the same in all three, your scores can differ.

Each bureau has a different name for its FICO, but they all come from Fair Isaac:

Equifax = BEACON Score

TransUnion = EMPIRCA

What about Experian, the other of the big three credit bureaus? If you attempt to buy a FICO score from Experian, you’ll be out of luck. Experian offers its own, non-FICO credit score for purchase.

Fair Isaac has a fairly tight grip on the credit scoring industry, but that doesn’t mean that no one else has developed their own credit score algorithms. The catch? These scores might not be what lenders — particularly mortgage lenders — use to determine your creditworthiness.

FAKO Scores and Your Credit

Other credit scores have acquired the designation FAKO (from “fake-o”). For the most part, these are not FICO scores. Instead, they are scores from companies that have developed their own scoring models. These scoring models look similar to FICO scores, and even have a similar scale. Some examples include:

VantageScore:

This is a scoring model developed by the three major credit bureaus together. It includes information from all three reports. You can get your VantageScore from each of the three credit bureaus. It was designed to compete with FICO, but so far, few lenders actually use it.

PLUS:

Experian developed its own credit scoring model, based on information in the Experian report. However, this is a consumer credit score and not used by lenders. It’s purely educational.

TransRisk:

The credit bureau TransUnion developed the TransRisk score based on information from that bureau.

Experian credit score:

This is a score based on the information in your Experian credit report and based on Experian’s proprietary model.

It’s true that these scores can provide you with a general idea of your creditworthiness, but since they are not widely used, they might not actually tell you how lenders see you.

Alternative scores can help you keep tabs on your credit situation and alert you to potential problems, but they can’t replace your FICO score.

Where to Get Your Credit Scores

You can buy your FICO score directly from the source at myFICO.com, but you can also purchase your FICO score from two of the three major credit bureaus.

TransUnion and Equifax each sell a version of the FICO score based on their own information. Each of the three major bureaus also sells a score based on their own models, and you can purchase your VantageScore from each of the bureaus.

While it might be worth it to purchase your FICO score, though, it usually isn’t worth the cost to purchase a FAKO score. You can usually find these alternative scores for free at web sites like Quizzle, Credit Karma, and Credit Sesame. Keep tabs on your situation with free scores, but if you are serious about fixing your credit before applying for a major loan, check your FICO score.

It’s also important to watch out for those “free credit score” web sites. First of all, most of them offer FAKO scores, rather than FICO scores. Secondly, you normally have to sign up for a credit monitoring service in order to get your “free” score. You are much better off going through official channels to get your credit score.

What About a Free FICO Score?

While it’s fairly easy to find FAKO scores for free, getting your free FICO score is a little more difficult. (Remember, your FICO score isn’t the same thing as your free annual credit report.) For the most part, you will need to pay $19.95 at myFICO in order to see your score. That’s $19.95 for one score based on one bureau, so you will have to pay another $19.95 for another score. (Experian charges $15.95 for its non-FICO score.)

It is possible to get a free credit score if you have been denied credit or if you don’t receive the best possible terms. However, lenders only have to provide you with the credit scoring method used and an explanation of why you were denied credit.

A recent law requires lenders to either provide you with the credit score used (so, if it’s FICO, you get the FICO score) OR provide you a Risk-Based Pricing Notice. This means that lenders can get around providing you with a free copy of your credit score by analyzing why you didn’t get the best rate or why you were turned down.

If you want to stay on top of your credit score at all times, you can sign up for Score Watch at MyFICO. They’ll send you alerts when there are changes to your credit score and provide you with tools to understand the factors affecting your score. The 1-month trial costs $4.94; each month after that costs $14.95.

Bottom Line

Your credit score is a numerical representation of your creditworthiness. Banks and other lenders use it to make judgments about whether to approve your loan, and what terms you receive. The most common score used is the FICO score; if you are going to pay for a score, make sure it’s that one.

Preferred Equity Real Estate – Some Background Context

Preferred equity is part of the real estate capital stack – in other words, a type of financing a sponsor or developer will employ as part of the aggregate capital raise for a given real estate project. In short, preferred equity is subordinate to debt, but senior to all common (or JV) equity.

Preferred equity is similar to mezzanine debt in function, but slightly different in form. Mezzanine debt functions as bridge financing, but rather than being secured by the underlying property, the sponsor puts up his common equity position as collateral.

Preferred equity, conversely, is typically entitled to force sale of property in the event of non-payment. Preferred equity also typically includes an “equity kicker” – an additional entitlement to profits in the event that the project performs well – whereas mezzanine debt does not. In other words, both mezzanine debt and preferred equity provide gap funding, seniority to common equity, and legal remedies in the event of non-payment, but bare some differences beyond that.

Preferred equity provides sponsors and developers a higher amount of leverage at a lower cost than common equity (assuming that the project performs well and to expectations). For preferred equity real estate investors, it provides the opportunity to capture a fixed rate return with priority of payment and some upside.

Why Invest in Preferred Equity Real Estate

Preferred equity offers a hybrid risk/return profile between senior debt (which typically carries the added security of a first lien on the property, as well as first payment priority) and common equity, which carries unlimited upside but is subordinate to all debt and preferred equity.

Preferred equity investments typically offer a robust flat annual rate of return, as well as the aforementioned “equity kicker” – the opportunity to share in the upside of the project. In many cases (though not all) the exit is projected at refinance or partial sale, making the term shorter than the average common equity investment.

Thus, preferred equity real estate investments are attractive for those investors that like the predictable annual returns and regular distributions of a debt investment, and are willing to sacrifice some downside protection in exchange for an additional layer of upside potential – the “equity kicker”.

Preferred equity real estate investments typically offer current annual preferred returns between 7-12%*, and total preferred returns (including the equity kicker or accrued return) between 10 and 15%*.

Preferred equity real estate investments are also an attractive vehicle for yield during periods in the market cycle when a correction feels likely, if not inevitable and imminent (market conditions as of this writing could be described as such).

To summarize, these are the main reasons preferred equity real estate investments are attractive:

• More upside than senior debt-based real estate investments
• Payment priority over common equity holders
• Downside protection (particularly attractive at or beyond a likely market peak)

Preferred Equity Real Estate Investing vs. Debt and Common Equity

Should you allocate your entire real estate portfolio to preferred equity real estate? Hopefully we’ve made a compelling case for this type of investment, and indeed you may want to devote a substantial portion of your real estate portfolio to preferred equity, especially at this point in the market cycle.

However, this should be considered another opportunity for diversification: diversifying across senior debt, preferred equity, and common equity – and, by extension, diversifying across hold periods – can help mitigate liquidity risk.

The precise mix of debt, pref. equity and equity investments should be driven by your overall goals and strategy; your tolerance for risk and need for liquidity.

Preferred equity real estate as part of diversified hold period strategy.

A hypothetical portfolio of debt, common equity, and preferred equity real estate investments.

With reinvestment of repaid debt investments, the investor is projected to enjoy regular cash flow that increases throughout the 7 year period, with the initial capital outlay recovered within 4 years and the potential for substantial upside through years 4-7.

The basic premise is similar to the “100 minus your age” theorem of stock vs. bonds allocation (that may be more superstition than theory at this point) – while you should reduce the portion of high-upside, high-potential-return investments in your portfolio the closer you get to retirement and the more risk averse you are to begin with, devoting some of your portfolio to longer-term appreciation and upside will aid the growth potential of the portfolio overall. By staggering the projected term of your investments, you can put yourself in position to reclaim capital for reinvestment and/or to have more liquid assets on hand.

How to Make A Commercial Property Stand Out

Optimizing properties is about more than installing new appliances and a fresh coat of paint. Here’s a step-by-step playbook to help landlords target niche demographics and optimize their properties to maximize value.

Understand your tenants:

Always be transparent with clients and let them know how the value you present meets their needs, with an emphasis on accommodating their budget.

Trustworthy landlords not only empower tenants to confidently buy or rent from them, but may also ultimately improve their own bottom line with higher sales. When both you and the tenant understand the meaning behind what you’re charging, both sides can feel confident that they’re getting the most out of the transaction.

Understand your property:

Just like people, buildings age and require maintenance. Understanding the values and faults of your property helps fix problems as they happen, not as they spiral out of control. The last thing you want to sell is a flawed piece of property.

Location:

Connect with the property’s neighborhood to understand of what you’re presenting to clients. Knowing about amenities, transportation and demographics only scratch the surface — if you’re serious about investing in a particular neighborhood, consider opening local offices to show future tenants that you’re serious about the area they’re considering living in.

Renovations:

Regular property inspections allow landlords to find problems with the unit’s structure right away. Renovations and updated finishes can increase your asking price. Based on property type, consider what kind of renovations will pop up in the future.

Develop a unique strategy based on that understanding:

Powerful and unique marketing strategies separate the best landlords from the rest. Strategies materialize from a deep understanding of your properties and the tenants you want to attract.

Data-driven leasing:

Over the years, I’ve seen the more renters have lease terms that appeal to them, they are more likely to stay at a property. Today’s best leasing solutions use data and predictive analytics to assess patterns in consumer behavior so that landlords can attract and generate more qualified leads. Data allows landlords and brokers to work together to reach the right audience.

Timing:

Consider the timing and execution of your construction schedule. Marketing units during peak seasons can attract the highest rents and keep leases in the right cycle. These concerns demand collaboration between landlords, brokers, and contractors to deliver high-quality luxury units when the market needs them most.

Real estate isn’t easy, and success requires more than drive. It calls for a deep understanding of the fundamental appeal of a great property, and without a solid underpinning, you’re selling facades rather than strong foundations.

Prospecting 101 For Commercial Real Estate Professionals

One common thread links the newest commercial real estate sales or finance professional to the most seasoned commercial real estate veteran.

The need to acquire new clients and maintain existing relationships. Without clients, you don’t have a business, so prospecting is the lifeblood of any brokerage firm. And the most effective way to turn prospects into clients is to pick up the phone and have a conversation with them.

You enter the business cycle by going to the market to find prospects with whom to do business.

Once you have found a prospect, you analyze their needs, make a presentation, and win the right to represent them. Of course, winning the business isn’t enough, since you also need to fulfill the assignment and close the deal.

All these steps are important, but many commercial real estate sales and finance professionals place their emphasis on the win and fulfill stages. To keep your brokerage pipeline healthy, you need to always keep re-entering the cycle by finding new prospects. This keeps all three buckets in your sales prospecting continuum full.

Building a Prospect List:

Before you pick up the phone, develop a solid strategy based on two essential elements: determining who your prospect is and what you are going to say. You can have the best list in the market, but if you cannot clearly articulate the purpose of your call and the value to your audience, your great list is worthless.

Alternately, you can have a silver tongue and deliver consistently, but if your calling list is outdated and not validated, you are not any better off than the broker in the first situation.

Two popular research sources for company information are Hoover’s and LexisNexis. Hoover’s “First Research” product provides good insight and suggested questions for key decision makers. For more direct research, leveraging an online assistant such as Elance or Guru allows you to delegate your research activities.

The next step is to determine whom to call. When building your prospecting database, try to only include the most qualified prospects.

Formulating Your Presentation:

Once you’ve identified your prospects, research what would interest them. This last step is often forgotten. Determining a prospect’s issues gives you a good reason to call and move the relationship forward. Learning about them, their companies, and their real estate needs can help you to have a more pointed conversation that is more likely to lead to a face-to-face meeting.

Making the Call:

Once you have finished preparing, generate a call list so you can sit down and do your prospecting in one block of time. As you go through your call list and contact your prospects, remember the reason that you are calling — to get the prospect to sit down with you.

If the client says yes, book the meeting and end the call as quickly as possible. Send a confirmation via email and, if the meeting is more than one week out, send additional information between your call and the appointment that adds value. For example, if you are meeting to discuss a lease, send a client testimonial regarding a lease you just renewed or a tenant you successfully relocated.

When the prospect says no, try to find an area of interest that you can use to book a meeting. Remember the cardinal rule of WIFM. Use your research to address possible business issues the prospect is facing, or share what their competitors are doing in the market. Also, if the prospect is rude or hurried, consider that you may have called at a bad time. In that case, call back in one to three months.

When the client asks you to send information, consider offering to send it as long as they agree to have another conversation with you to discuss it. You can send the information without such a commitment, but inevitably you will end up chasing the prospect for weeks if not months.

If the prospect isn’t interested in meeting with you, find out why. If the timing isn’t right for them, attempt to get a sense of a better time to call. This is also an excellent opportunity for you to re-examine the value proposition that you’re presenting on the phone. If it’s not compelling, you probably will get a lot of uninterested responses. Sharpen your pitch and call them back in one to three months.

Commercial Loan Programs

Winston Rowe and Associates has almost 200 capital sources nationwide. This enables us to provide a full spectrum of options to clients that traditional banks and many lenders can-not.

Capital Deployment:

• $1,000,000. – $50,000,000.
• 48 Contiguous US States Only
• SBA, Hard Money, Bridge, Portfolio, CMBS, Conventional, Private Capital, Preferred Equity, Mezzanine and Private Equity.

Loan to Value Criteria:

• Refinance 70% – 80%
• Purchase 70% – 80%
• Cash Out Refinance 70% – 80%

Documentation Criteria:

• Full and Limited
• No FICO or Low FICO Score
• Asset Value Only
• Income Approach / Cash Flow Only

Basic Underwriting / Due Diligence Criteria:

• Personal Financial Statement
• Purchase Agreement
• Three Bureau Credit Report
• Use of Proceeds for Cash Out
• Valid Government Issued Photo ID
• Completed and Signed Transaction Summary Questionnaire from Winston Rowe & Associates
• Populated Supporting Document Due Diligence List. Pursuant to the specific transaction type.

Commercial Property Types:

• Our capital sources will consider vacant and occupied commercial properties.
• All commercial property types considered.