Real Estate is broadly classified as residential and non-residential property. A property is deemed commercial when it is non-residential, used for business purposes like office space, or rental accommodation, shopping centers and malls etc.
Commercial Construction Loans are primarily meant to build a profit creating business or enterprise. Commercial Construction Loans may also be used to expand a business, acquisition of land, refinance, and construction. The property held as lien could be any Real Estate such as a plot of land where construction is to begin, an apartment complex or the business space that needs to be upgraded.
Commercial construction financing works in two steps :
The first step is the 'acquisition and development' loan, which finances the purchase of buildable land. In this scenario the lender puts up 50% of the entire cost. If the land is available and ready for construction with all approvals in place, the lender can go a bit higher but the general financing in this stage is 50%.
In the next stage is the 'construction loan', the finance that you can borrow during the construction period through structured plans and depends on two factors :
Loan to Value Ratio : The factor taken into account here is the value of the land and value of the completed structure. Generally this is 75% loan to value for commercial construction.
Loan to Cost ratio : This is the maximum amount you can borrow related to your construction expense.
Since commercial construction loans rely on many factors that are not very tangible, that is on factors that are projections of profit, the process to acquire a loan is also very stringent. Hence a commercial construction loan proposal needs to elaborate very clearly the objectives and plan of the project undertaken, for the loan to be approved.
The first essential to be listed is the executive summary. The executive summary gives a complete planned summery of the project in paragraph form, detailing the project, its necessity, location and the strengths of the project that will make it profitable.
The second essential item is a complete resume of the principals involved in the project, and the contractor who has been awarded the construction of the project. The resume must also include a list of all successfully completed projects. Work experience specific to the project is a key factor for loan approval.
Pro-forma projections of the project, expected income and profits, a complete cost breakdown analysis and time frame ought to be included. Data on property demographic, absorption studies and marketing strategies should also be included. A planned and detailed summary helps in approval of the loan. Incomplete reports often do not qualify for loans.
Financial statements of the involved principals, the contractor is required too.
If the construction is a commercial complex, apartment building, or an office space then information of all pre-sales must be provided with legitimate paperwork and proof. A 50% presale works in your favor when the loan comes up for approval.
The important consideration for a commercial construction loan is money, experience and pre-sales.
Most commercial construction loans are short-term of say, 2 years. Some loans have acquisition costs factored in them.
Commercial banks are the first choice for commercial loans. If your project does not qualify, you can explore other less strict options such as a private or sub-prime lender. Private lenders though less stringent charge more interest up to 10% - 15%.
Portfolio lenders : These lenders finance a commercial loan with the aim of retaining the property as part of the company's portfolio. These lenders generally are commercial banks, life insurance companies and to some extent pension funds, REITS, and investor funds.
CMBS Conduit lenders : Commercial mortgage backed securities (CMBS) enable investors to take part in a commercial mortgage within a certain reference frame. Commercial loans that the conduit finances are part of portfolio of assets that are then sold to the investors.
Sub-prime lenders : These lenders provide finance to lenders whose credit scores do not permit them to avail loans through conventional means.
Private investors and funds : This category of lenders is more flexible than other lenders and obtains the 'hard money' from private individuals or groups. They are willing to finance high-risk projects in favor of high returns.
Banks generally finance short to mid term construction loans, mini-perm loans, and loans under $200,000.
Sub-prime and private lenders offer loans, such as bridge loans, low credit loans for projects that do not follow stringent guidelines.
There are several types of commercial construction loans, but they can be broadly grouped into categories based on three factors.
Many different agencies take part in financing commercial real estate by insuring loans issued by approved lenders. The government manages quite a few of these agencies and others enjoy assistance in the form of tax-deferment or exemption.
SBA Loans : The Small Business Administration is a government organization that finances real estate occupied and run by small businesses. Financing loan amounts less than $200,000, the aim of these loans is to aid in purchase or acquisition.
FHA/HUD Multifamily Commercial Loan : The FHA is a loan issued by the US Department of Housing and Urban Development. The primary aim of the loan is to encourage home-ownership but it also finances a range of insurance for purchase and construction of multi-family commercial properties, assisted living and healthcare facilities.
Mezzanine Loan : These loans are an option when the term of a superior loan does not allow a second lien on the same property. The mezzanine loan is not secured by a trust deed on the property but by stock in the property. A mezzanine loan is loaned by a bank or a conduit lender that has financed the superior loan with a term of three years. A 'hard money' lender also offers a mezzanine loan with a similar term but with a 15% interest rate and higher fees.
Hard Money Loans : Private lenders finance projects that are deemed to risky for conventional lenders. They charge high front fees (3 to 6 points) and a higher interest rate (10%-15%). They also limit the loan to value ratio to 65-70%). These loans are a short to medium term (1 to 6 years). It is used for all real estate financing, commercial complexes, restaurants and hotels etc.
Real Estate : This is a type of bridge loan financed by conventional lenders for the purpose of acquisition and construction of real estate and to establish a working business in order to obtain a term loan.
Bridge Loans : A bridge loan is issued by private lenders and is the initial loan necessary for acquiring and operating a commercial enterprise before obtaining a permanent conventional loan.