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 these setbacks onsite is challenging enough. If you’re not working with the right commercial banker, you might unknowingly add a few more obstacles to that list.
It’s always best to prevent complications from arising in the first place. 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 article will explore the basics of commercial construction lending, provide some insider tips, and explain how the right banker can be your saving grace in an otherwise challenging industry.
What is a commercial construction loan?
A commercial construction loan is a short-term financing option designed for business owners, construction companies, developers, builders, or anyone looking to finance the construction or renovation of a commercial building. These loans may also be used as a stop-gap measure while a long-term financing solution is being pursued. Its draw schedule, or contractor payment plan, helps pay each contractor and subcontractor on a schedule as their work is completed to keep your project moving forward. In many cases, construction loans will have a provision that will allow the construction loan to convert to a long-term permanent loan at the end of the construction period (construction-to-perm, as it’s known).
How commercial construction loans work
With most loans, the borrower receives the dollar amount of the loan at closing. Conversely, when securing a commercial construction loan, the bank will release 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. If you already own the land, the equity that you have in that property can be used as your down payment for your construction loan.
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 are also available through the U.S. Small Business Administration (SBA). 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 banker, they’ll be able to suggest the lending options they believe will be best for your business and help guide you through the process.
Common types of commercial construction loans
Finding the right lender is essential, as they can assist with keeping your project on track and help you avoid 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 Community First Bank, our lending team understands the construction process, and we will help guide you to the right loan to help your business in the short- and long-term.
SBA 504
An SBA loan can help finance projects up to $5 million with low down payment options and competitive rates, making them a popular solution for both borrowers and lenders. As an experienced SBA 504 Lender, Community First Bank can provide high-level guidance throughout the approval and closing process.
Conventional Bank loans
Rates, repayment terms, and down payment requirements vary for a conventional commercial real estate loan depending on your past and present financial circumstances, the lending market, and which lender you choose. Don’t assume that all banks and lenders are the same. They’re not, and the services, rates, and relationship that a lender offers can vary from one lender to another.
What services does an experienced commercial construction banker provide?
No one likes fees, but they come with the territory. At Community First Bank, you’re actually getting quite a bit of hard work for your money, and it’s done by real people who will be with you throughout the entire construction process. For every project, our team will begin with a full budget and contractor review, providing draws, monthly budget reviews, change orders, and other management services along the way.
Additionally, depending on your project, our work will include the following:
1. An upfront review
- Source & use budget analysis
- Initial budget assessment
- Contractor due diligence and approval
- Help with understanding of the size and scope of the project
- Discussion of the loan structure (SBA or Conventional)
- Understanding how much cash is needed for the project: down payment (usually 20-25%) and post-closing liquidity requirements (generally around 10% of the total project cost)
- If the commercial property is planned for tenant occupancy, understanding cap rates, net operating income (NOI), the income approach value of the property, debt-service coverage ratio requirements, and more
2. Monthly reviews
- Monthly budget assessment
- Retainage monitoring and retainage release to sub-contractors
- Response to change orders
- Collection of lien waivers
- Inspection reporting
- Title, lien, and tax updates
- Second file review to confirm a balanced budget
- Final sign-off to fund the draw
- Wiring of funds to the contractor
- Soft cost payments, directly and to other vendors
3. An end-of-project review
- Certificate of occupancy
- End-of-year 1099 reporting sent to the vendor and IRS
Finding the best commercial construction lender
You already know to expect the unexpected when it comes to any new commercial construction or renovation project. The right banker will get to know your business almost as well as you do. This will help them identify any risks in your construction plan and guide you through potential pitfalls before they impact your budget and timeline for a project. That’s why Community First Bank has a dedicated construction lending team with decades of experience in the industry.
Our team will also be with you through the life of your loan, and we pride ourselves in being available when you need us. When working through rapidly changing circumstances, you need to have open communication with your banker. It’s nice to know that your team will know you by name, understand your project, answer questions, and offer solutions quickly.
Choosing a banker may seem like an insignificant part of the process, but for many of our clients, our responsiveness and “pro-closing” approach have been vital to turning even the most frustrating projects into rewarding and memorable experiences.
If you are interested in securing financing for your next commercial construction project, contact our Commercial Lending Team today.
David Doak
Business Banker
NMLS ID# 123911
