Whether a new business is looking to construct its first physical location or an existing company has plans to expand operations, there comes a time for many enterprises when real estate construction or upgrades become a part of their growth strategy.
Commercial construction often comes at a high cost—between the labor, materials, permitting and more. So, it’s common for businesses to take out commercial construction loans or secure a construction line of credit to finance such projects rather than paying for them upfront.
Additionally, there are some unique attributes of commercial construction loans that make them different from traditional loans. Therefore, it’s important for business owners to understand the structure of these loans, including the repayment terms, how to qualify and where to apply.
What are Commercial Construction Loans?
Commercial construction loans are a type of financing that can be used to pay for the costs related to constructing or renovating a commercial property. These loans can cover labor and material costs, land purchases and renovations.
Why Should You Finance Construction Costs?
With many commercial real estate projects costing upwards of hundreds of thousands or even millions of dollars, it makes sense why business owners rely on commercial construction loans. Equally, these loans make sense from a budgetary perspective in that business owners can pay back the capital over time versus paying for construction outright.
How It Works: Construction Financing
Commercial construction loans differ from normal loans in a number of ways. Namely, there is a major difference in how the borrower receives funds when applying for construction financing compared to a standard loan.
Rather than receiving the borrowed funds in a lump sum upon approval like a standard loan, they receive portions of the loan over time as they achieve certain milestones. Those milestones can be land development, foundation pouring, framing, etc.
Additionally, the borrower only pays interest on the portion of the loan that was used. This means that any unused funds are returned to the lender, and the borrower does not pay interest on that remaining balance.
On the same note, construction loan borrowers typically only make interest payments until the project is complete, then they are expected to pay down the principal. For a construction loan, the max repayment terms tend to be 25 years.
When construction is complete, the business can convert the construction loan to a permanent loan, using the building as collateral. Oftentimes, this can offer more favorable repayment terms and is a commonly used option after construction concludes.
There are certain qualifications that a construction project needs to meet to qualify for a construction loan. First, construction projects are inherently high-risk, so lenders will prefer applicants with higher credit scores. The minimum credit score a lender will require depends on the individual lender and the type of construction loan being requested.
Second, lenders will take a look at the business’ financials, business credit score, cash flow, industry experience, debt-to-income and debt-service coverage ratios for further assessment.
Most commercial construction loans have rates between 4%-12%, depending on the borrower’s credit score and the lender.
Most commercial construction loans will require a down payment, which is generally 10%-30% of the project cost.
Where to Apply for Construction Financing
Many lenders, credit unions and banks offer a variety of options for construction financing, including SBA loans, traditional loans and mezzanine loans. Additionally, hard-money lenders can offer short-term financing options for commercial construction projects, though they typically come with a higher interest rate.
Applying for a construction loan is not an overnight process. However, understanding what projects qualify for a commercial construction loan and how they operate can help business owners be better prepared to pursue construction financing when they need it.
Extensia Financial: a Commercial Construction Lender
Established in 1998 and headquartered in Simi Valley, CA, Extensia Financial partners with credit unions and brokers to connect them to investors across the United States. For decades, we have offered competitive and collaborative construction and commercial loans and uniquely support and guide our partners through the entire lifecycle of our loans. Extensia Financial is a proud member of the AVANA Family of Companies.
Contact us today to learn more about becoming an Extensia Financial partner.