The Multiple Stages of Construction Financing
The Multiple Stages of Construction Financing
When you need to obtain financing for your real estate investment project, there are many factors to consider, whether you’re building a single-family home, acquiring raw land, or developing a multifamily property. In fact, each stage of the construction process can be financed separately, with each part of the process requiring capital to add value to the project. Regardless of whether you’re looking to sell a project for a profit or transition it into the next phase of its development, be sure to work with an experienced lender that is well-versed in the property type you’re working with.
In this article, we’ll explain the different stages of real estate development and how appropriate financing can add significant value to each one. Identifying these details upfront is a critical part of a real estate project that will be successful, regardless of the stage in which you choose to get involved.
Raw Land Loans
Purchasing raw land may be right for you if you want your project to be fully customized and you’re not concerned about taking some extra development time. You may want to purchase an infill lot in a dense, urban location, or land in a suburban area that can be platted into individual lots to build multiple structures. A land loan will allow you to purchase this piece of land on which to build your development.
A key factor to consider when examining the risks of purchasing land is the marketability of the land and how it will affect any future projects that will be built upon it. Some lenders consider themselves “land banks,” and specialize in funding the purchase of raw land before the profitability of a project can truly be determined, adding to the risk associated with the loan.
Other lenders participate in raw land acquisition with certain requirements in place. Typically, this includes cross-collateralization of other properties and evidence of feasibility work. Generally, a path to entitlement and the ability for the lender to finance future stages of development are crucial prerequisites for these types of loans from “non-land bank” lenders.
Horizontal Development Loans
Horizontal development refers to obtaining entitlements and adding infrastructure to prepare a piece of land for vertical construction. For example, this includes finalizing the permitting on the land, installing utilities, or laying a concrete pad. Generally speaking, a horizontal development loan will include a combination of these elements.
In many cases, borrowers may not have access to the capital that is required to move a project into its next phase (vertical construction). Horizontal development loans can help bridge this gap. At this stage, if you have an existing land loan that you’re looking to refinance, loans that are over-leveraged make it difficult to do so without an additional capital commitment. Seek a lender that underwrites for the vertical construction phase in tandem with the horizontal phase and does not rely too heavily on leverage. This ensures there is enough equity for vertical construction so there is no need to raise additional capital. Additionally, this will allow you to refinance with another lender if the original lender is not providing financing for the vertical construction phase.
Vertical Construction Loans
The vertical construction phase is what most people think of when they imagine a property being developed, and entails the actual construction of the structure. It can involve a variety of asset types, including developments of single-family homes, apartment buildings, townhomes, or condominium complexes.
Typically, most of a construction loan is held back in an escrow account that is released on a certain schedule after a pre-determined portion of the construction is complete and verified by an inspector. This minimizes risk for the lender while providing the borrower with the funds needed at each stage of the process.
Once a project is complete and before its full profitability has been realized, financing is often needed to stabilize it. For an investment property, this means generating income. Stabilization is typically required to qualify a property for permanent financing that will carry it throughout its lifecycle. If a borrower cannot lease a property, they will need to work with the lender to determine a path forward (i.e. negotiating modifications to the loan).
As we’ve demonstrated, obtaining financing at these various stages of your development is a critical component to ensuring its success. Be sure to work with a lender such as Broadmark Realty Capital that has the experience, strong balance sheet, and technical expertise to maximize the value of your real estate project, regardless of the stage at which you get involved.
Broadmark Realty Capital Inc. (NYSE: BRMK) is an internally managed real estate investment trust (“REIT”) offering short-term, first deed of trust loans secured by real estate to fund the acquisition, renovation, rehabilitation, or development of residential or commercial properties. The company has originated over $2.2 billion in loans since its formation through a rigorous and responsive underwriting process. Have questions? Contact one of our lending experts today.
Broadmark Realty Capital lends in Denver, Florida, Georgia, Idaho, Maryland, North Carolina, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Virginia, Washington, Washington D.C., and Wyoming.
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