Commercial Construction Loans
by A. Heinrich
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Obviously, a construction loan is a loan that allows the borrower to build, expand, rehabilitate, or reposition a property. As such, these are short-term loans, generally with a maximum 2 year term. At times acquisition costs may also be built into the loan. Commercial banks are the most likely source for conventional construction loans. For projects that do not adhere to the sorts of rather strict guidelines required by banks, a borrower may find it necessary to seek a loan from private or sub-prime lenders. Private lenders will generally be far more flexible concerning the borrower credentials and assets and property type, while charging much higher interest rates (e.g. 11% - 14%).
Example scenario #1: A well-established developer with strong assets and good credit is building a 6-unit shopping center on land he currently owns free and clear. Construction costs will be $750,000. Since the borrower will pay all fees and closing costs out-of-pocket, and will provide $150,000 of the construction costs. With a loan amount of $600,000 the loan-to-cost ratio is an acceptable 80%, and the borrower is eligible for a construction loan from a bank at 150 basis points (1.5%) over prime with 25 year amortization and a 2 year balloon.
Example scenario #2: An experienced developer with relatively low assets and mid-range credit (625) is seeking funds to build a 6-unit shopping center on land he currently owns. Construction costs will be $750,000. The borrower owes $200,000 on the land, which he has had appraised, as-is, for $375,000. He has also obtained an MAI projected-value appraisal for the shopping center which establishes a finished value of $1,500,000. The borrower is therefore seeking a loan of $950,000, and can only bring fees and closing costs into closing.
Because of the borrower's financial and credit situation, and his inability to bring sizeable cash equity into the project, he would most likely not be eligible for a bank construction loan. However, this is a perfect private money scenario. Since the projected LTV is 63% and the as-is LTV is 53%, there is ample equity to secure the private investor's loan without relying on the borrower?s financial situation. Terms of such a loan would be something along the lines of 13% interest-only payments with a 2 year term, with 400 basis points (4%) as a fee to the lender at closing.
A construction-to-perm loan is essentially just a construction loan and term loan packaged as one product and committed to simultaneously. As such the terms will simply be split between the construction and permanent phases. Commercial banks will be the most common source for this type of loan.
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