Commercial and development construction loans are difficult to navigate. A large developer with a long track record may have an easier time securing a construction loan, but small investors with not much capital to contribute will find that commercial construction loans are rather difficult to obtain.
There are more and more lenders offering construction loans, but you’ll find that the vast majority of loans come from two lenders: regional or local community banks. This is due to previous bank regulations that placed restrictions on areas where lending can occur for banks and commercial purposes.
But regulations have loosened somewhat, allowing for a larger group of lenders.
Financing can also come from:
– National banks
– Life insurance companies
– Specialty finance forms
The reason why most community and regional banks provide the loans for commercial and development construction is that these entities know the market’s area better than the competition. For example, a bank in Orlando may provide you with a loan to build an apartment complex because the bank knows the demand for affordable apartments in the area.
A bank in Neptune, New Jersey may not provide you with a loan because the bank doesn’t know the Orlando market well enough to ensure that their investment isn’t a high risk one.
Major construction loans are almost always likely to come from local lenders, so it’s in your best interest to search for your loan locally rather than going to national lenders for funding. If you have exhausted the local lender market, this is the time to spread out to national lenders and other lending outlets.
The best way to determine which banks to apply for first include:
1) Making a list of all of the banks in the area.
2) Determining lending requirements of each bank
3) Researching typical loan interest rates for each bank
And if you can’t find any information about the bank or lender, reach out to a loan manager and talk to them. Lenders are interested in solid construction projects and will help you navigate the loan application process. They will also discuss what will work best in your circumstance.
A few outlets that you can research outside of your traditional bank includes:
– Credit Unions: The growth of credit unions is massive, and these entities are often more flexible in their requirements for a loan. On the downside, credit unions often follow the same rules as banks because they often sell their loans to other lenders.
– Portfolio Investors: A tricky investment option. Portfolio investors will fund the development with their own funds, and these entities will not sell the loan to another lender. Portfolio investors is often the ideal choice for larger developers that have a history of smart developments and a credit history.
What most people overlook, especially with smaller development projects, is the mortgage broker. A mortgage broker can be an individual or company that will do all of the hard work on your behalf. These professionals will be able to scour hundreds of loan options and find the best loan possible for your development.
These individuals often work on commission, which will be tacked onto the loan at the time of closing.
It’s important to find a mortgage broker that is highly respected and experienced in the industry, as he or she may have more experience and a larger network to help you land a loan.
When construction loans are given, there are normally two loans that will be taken out. These loans make a lot of sense to lenders as they lower the overall risk for both parties. When applying for loans, you’ll need:
– Short-Term Loans: The short-term loan is meant for you to finance the entire construction of the building. This loan is given to get the development process to completion.
– Long-Term Loans: Long-term loans offer more favorable rates and durations, and are considered permanent loans. The idea behind the long-term loan is that you can accept favorable rates because you can show that you’ve leased out some of the building space, apartments and so on to prove that there is a demand in the industry.
Long-term loans are what you should seek when you have leverage to show the lender that there is demand and you’re able to lease out the building. The long-term loan will pay off the short-term loan.
There are also such things as mini-perm loans.
Mini-perm loans allow you to pay off the construction loan before refinancing.
Commercial loans are provided to the following projects:
– Non-residential properties
– Properties consisting of 5 or more units
When trying to land commercial or development loans, the above tips above will allow you to secure a loan. But what are the lenders looking for in the ideal borrower?
– Debt to Income: The debt to income ratio of the borrower is important up to a point. A bank will not take personal income into account as much if your job doesn’t provide the means to pay off the loan. Instead, two things will come into perspective:
– The borrower’s ability to manage the business and experience level
– The property’s ability to provide cash flow to pay the loan
– Credit History: The credit history of you or your business will be considered. A credit score that is high demonstrates that you have the ability to manage money.
– Loan to Value: The loan to value ratio will be a factor. Banks don’t want to be over-leveraged, and the lender will want a high equity in the project so that if the worst happens, the lender can foreclose and sell the property to satisfy their interest in the project.
– Debt Service Coverage Ratio: This is a metric that is provided only in commercial development loans. This is a ratio that looks at the property’s ability to generate cash flow. If the property doesn’t have a good ratio to generate cash, the lender will be at too high of a risk to lend money to the borrower.
Lenders look at you as an investment, and you need to prove that your development project is a safe bet. If you can prove the potential of a property and have experience within the management field of the property, you’ll be able to secure a loan.