The process begins when a developer submits credit request with a lender. Construction or development lenders are generally local community and regional banks. Historically i thought this was due to bank regulation that restricted trade areas for lending. More recently, life insurance companies, national banks, and other specialty finance companies have also started making construction loans. However, community and regional banks still deliver the majority of construction financing, as they have a much better understanding of local market conditions as well as the reputation of real estate developers than larger away from area banks.
There are two normally two loans needed to finance a real estate development project, although sometimes these two loans will also be combined into one:
- Short term financing. This stage of financing funds from the and lease up phase of the project.
- Long term permanent financing. After a project achieves \”stabilization\” and leases approximately the market level of occupancy.
When a bank combines these two loans into one it is usually in the form of a construction and mini-perm loan. The mini-perm is financing that can out the commercial real estate financing, but is shorter in duration than traditional permanent financing. The stage that the mini-perm is to pay off the construction loan and supply the project with an operating history ahead of refinancing in the perm market.
Land and Construction Loans and Commercial Lenders
Land and Construction Loans: Underwriting
After your initial loan request is submitted, your budget typically goes through a quick internal go/no-go decision process. If your project is given the go-ahead from the bank\’s senior lender, the lender will sometimes issue a condition sheet which outlines the conditions and terms of the proposed loan, provided all the information presented is accurate and reasonable. Once the non-binding term sheet has been reviewed, negotiated, and accepted, the bank will move forward with a full underwriting and approval within the proposed loan.
During the underwriting process the loan originator will evaluate the proposed project\’s proforma, the information of the construction budget, the neighborhood market conditions, the development team and financial capacity from the guarantors, and in general address another risks inherent in the loan request. Typical documents required in the underwriting process include borrower/guarantor taxation statements, financial statements, a schedule of real estate owned and contingent liabilities for that guarantor(s), the proposed project\’s proforma, construction loan sources and uses, cost estimates, full project plans, engineering specifications, plus general, any other documents that could support the loan request.
From an underwriting standpoint, one of the more notable differences between land and construction loans and a investment commercial real estate loans is that with a construction loan there\’s no operating history to underwrite. The economics in the project, and thus the valuation within the property, is based solely on the real estate investment proforma. The credit approval process is comparable to other commercial loans, but with the additional risks inherent in construction loans, further consideration is offered to the development team and contractor, as well as the prevailing market conditions.
Once the land and construction loans are approved, the lender will issue a binding commitment letter towards the borrower. The commitment letter is similar to the definition of sheet, but contains additional detail about the terms of the loan. Additionally, the commitment letter is usually a legally-binding contract whereas the term sheet is non-binding.
Land and Construction Loans Closing and Beyond
Upon finishing of the loan underwriting and approval, that loan then moves into the closing process, which might take on a life of its own. Land and construction loans closings are complex and involve a massive quantity of documentation and procedural nuances. An closing is handled with the lender\’s attorney, the borrower, and also the borrower\’s attorney. A loan closing checklist is likewise normally issued to the developer combined with commitment letter, which outlines in more detail what needs to be completed prior to loan can close and funding starting.
After a loan closes, the loan mechanics are primarily the responsibility of the loan administration department inside of a bank. The loan administer (sometimes just referred to as loan admin), will fund the borrowed funds according to the internal policies and operations of the bank. Land and construction loans tend to be funded partially at closing to repay previously paid soft and difficult costs. After the initial partial funding, loan proceeds are disbursed monthly based on draw requests for costs incurred. These costs are submitted by the developer and verified via the lender.
Land and construction loans can quickly become complex and difficult to secure. But finding out how construction loans work and in what ways commercial developments are evaluated by lenders may help demystify the funding process. From now on posts we\’ll dive into some part of this process in detail. At the moment, if you have any specific questions about Land and construction loans, please tell us in the comments below.