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.
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.
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.
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.
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.
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.