How Do Commercial Construction Loans Work?

If you’ve struggled to find property for your needs or wonder if it is best to lease or buy property, consider a third option: development. Instead of searching for available inventory, you can build the commercial property you envision. 

You’ll need a commercial construction loan if you’re ready to develop vacant land and invest in a new project. Whether you’re starting from the ground up or making extensive renovations, this article will help you establish a firm foundation.

Learn more about commercial construction financing and how to approach a lender about your project.

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New Commercial Developments or Renovations

Once you find vacant land or real estate you want to renovate, you’ll develop a plan for your construction project and talk to a trusted lender. Obtaining a commercial construction loan and agreeing to a draw schedule is the best way to shoulder upfront costs.

Varying construction material costs have been on the rise since 2020. Inflation, supply chain issues and spikes in the price of steel, lumber and concrete have increased the cost of new construction over the last few years. Despite increased costs, new commercial developments are worth the investment. 

New commercial property benefits the surrounding community. It provides opportunities for new businesses and brings more jobs to the area. Once built, commercial real estate offers investors a steady cash flow and a chance to build equity.

How to Get a Commercial Construction Loan

You can use commercial construction loans to purchase land, buy building materials and pay workers. Most commercial construction costs are upfront, so the lender takes on more risk when financing the project. 

A higher-risk loan may require a larger down payment or equity contribution. Lenders will only finance part of the project. For commercial construction loans, many lenders ask for a minimum of 20% or more as the down payment. Then, the lender only pays 70 to 80% of the project. 

Before speaking to a lender, you need to have a strategic plan for how to use the financing during the construction phase. On top of that, having a detailed business plan for the finished property’s operation will help sell your case.

Obtaining Your Commercial Building Loan

1. Initial Discussion

The first step to getting commercial construction financing is to speak with a bank or trusted lender. In your initial discussion, you can share your needs and the big picture behind your project and loan application. You can also discuss your timeline and budget. 

The lender will guide you to the appropriate type of loan and answer your questions. They may encourage you to submit an application if they believe you are an acceptable candidate. 

2. Apply for a Construction Loan

The next step is to apply for a loan. You’ll submit your loan application and provide the lender with any necessary documentation. The lender will review your application and send you the terms of the loan agreement.

3. Submit Builder’s Contracts

The lender will need information about the construction company you hire. When you finalize contracts with your selected building company, you will send the agreement to the lender for reference. Lenders use these contracts in the next phase of the process: underwriting.

4. Commercial Underwriting 

Commercial underwriting is when the lender reviews all investor and project risks. After underwriting, the lender will determine if you are approved or denied for the loan. Lenders check your personal credit and financial history as well as your business’s cash flow, history and net worth. 

At this step, investors should hastily provide the lender with any requested follow-up information, documents or clarifications. If you’re purchasing land or property, the lender will have it appraised and perform a title check. 

The goal of underwriting is to determine if you will be able to pay back the loan. 

5. Appraisal 

As mentioned above, the lending financial institution will hire an appraiser. The appraisal will determine the current market value of the property. 

The appraiser will consider the proposed development or renovations to estimate its future value. After this step, the lender will have the property’s current and projected value. 

6. Loan Closing 

If the lender approves you for the construction loan, you and the lender will determine an appropriate draw schedule. The lender will tie your draw schedule to the milestones of the construction project. After completing milestones, you “unlock” portions of the loan. 

The lender will add these details to the commercial construction loan terms for the investor to keep for their records.

7. Break Ground 

Start building! You’ll make payments to the loan during construction. Typically, while you’re building, lenders let you pay on interest only. What you pay is based on only the portion of the loan you’ve already received, not the entire loan. 

8. Obtain Permanent Financing 

If applicable, you can obtain permanent financing. Construction loans have short terms. If you need longer to repay your loan, you may need to refinance or take out a separate commercial real estate loan.

You can also look for construction-to-payment loans that offer longer pay-off periods. These periods extend beyond construction. If you start with this type of loan, it transitions with you and doesn’t require added paperwork or discussions with your lender.

Types of Commercial Construction Loans

Developers and investors have several loan options and commercial construction loan requirements when considering their projects. Your business, finances and goals determine what type of loan you need. Additionally, these factors play into your loan eligibility. 

Before you apply for a loan, talk to a lender and financial advisor to make an informed, confident decision about your commercial construction financing.  

Loan Type About
Traditional Construction Loans A traditional bank loan can benefit borrowers with good relationships with lenders. You’ll receive financing based on a determined draw schedule and need to make a down payment. 
Mezzanine Loans Mezzanine loans are secured with stock so lenders can convert it to equity if the borrower needs more cash to pay off the loan or defaults. These loans give the borrower leverage but have higher interest rates. 
Takeout Loans Takeout loans are long-term financing after a borrower’s initial short-term loan. These long-term mortgages offer an uninterrupted flow of funds after an initial purchase or milestone. 
Mini-Perm Loans Mini-perm loans are temporary. These short-term loans often settle leftover balances on the original construction loan or provide financing before the borrower can obtain permanent financing.  

Small businesses can benefit from loan opportunities offered by the Small Business Administration (SBA). Businesses in the Branson, MO area can connect with the Missouri Small Business Development Center (MO SBDC) to get help applying for SBA loans

The following SBA loans can be used for construction:

  • SBA 504. With 504 loans, borrowers can use the money to purchase real estate, build facilities or improve existing structures and land. Repayment terms include 10- and 20-year terms. 
  • SBA 7(a). These SBA loans can be used for building and renovations. The 7(a) loans can be hard to obtain and qualify for; however, they are made to benefit small businesses with low interest rates and long repayment periods. 

Hire a Construction Management Company

Once you have a loan and can begin construction, ensure someone monitors the site’s progress. As a developer or investor, you may only be able to be on-site sometimes. Hire someone to represent you as construction takes place.

Every building project has a myriad of intricate details and tangled logistics. Each project phase must stay on schedule to keep work from lagging behind. A construction management company handles details and scheduling with builders, plumbers, electricians, painters and city officials. 

At Commercial One Brokers, we have the experience and area knowledge to help your construction project run smoothly. We’ve managed multi-million dollar infill projects and helped developers connect to the best local services. 

Contact the experts. Our team knows the ins and outs of Branson, MO area codes and regulations, and we always put your best interests first. Let’s break ground on your project! 

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