Skip to content

Tag Archives: commercial real estate funding

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.

stages of construction financing

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.

vertical construction loan

Post-Construction Loans

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).

Conclusion

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.

A Glossary of Hard Money Lending Terms

After rehab value (ARV): The market value that the investment property is expected to have after it has been improved or renovated.

Appraisal: A professional estimate of how much the property is currently valued or will be worth after updates.

As-is value: The property value as it exists, as of the appraisal date.

Bridge loan: A short-term loan used to bridge the gap between one obligation and the next. Bridge loans are a great way to move from one investment to another.

Capitalization rate: A real estate valuation measure used to compare different real estate investments. It represents the ratio between the net operating income produced by an asset and the original capital cost or its current market value.

Commercial use: A property with no residential component that is only used for a business.

Cross-collateralize: A lending technique in which collateral for one loan is also used as collateral for another loan.

Default: The failure, for longer than 30 days, to meet the legal obligations of a loan.

Distressed properties: Properties that are in poor condition or near foreclosure.

Draw schedule: A detailed payment plan for construction projects. This schedule helps hard money lenders determine when they need to provide funding to borrowers based on the work completed.

Escrow account: An account run by a third party that disburses payments based on the loan agreement. The money is typically used to cover property taxes and homeowner’s insurance.

Exit strategy: A real estate exit strategy is how the borrower plans to pay off the loan and reduce liability. It is a plan for how to exit one situation for a better one. Tip: have three exit strategies in mind – a best-case scenario, back-up, and “last-ditch” plans. Here are four common exit strategies.

Foreclosure: The process through which the lender legally takes control of the property due to the borrower missing loan payments.

Guarantor: The person who promises to pay a borrower’s debt if the borrower defaults on their loan.

Hard costs: Direct costs relating to the construction or improvement of a building or structure.

Hard money loan: Also called a private equity loan or a private money loan, a hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real estate property.

Holdback: The portion of a hard money loan that is not paid until the project reaches a certain stage, such as completion of the framing.

Holding costs:  Costs associated with owning a property for a period. This includes insurance, taxes, and utilities.

HUD-1: A form that lists all the transaction cash flows between the property’s buyer, seller, and lender.

Interest Rate: A percentage of the principal loan amount charged by the lender for use of money.

Lien: A legal form filed by a lender showing possession of property belonging to a borrower until the debt is paid off.

Liquidity: How quickly an individual or firm can purchase or sell a property due to having cash on-hand.

Loan broker: See: real estate broker below.

Loan officer: Person who evaluates, authorizes, or recommends the approval of loan applications.

Loan points: An origination fee. One point is equal to one percent of the loan’s principal amount. Two points on a $100,000 loan would be $2,000. Most private money/hard money loans fall between 2 and 5 points.

Loan to Cost (LTC) Ratio: Compares the financing amount of a commercial real estate project to its costs. It is calculated by taking the loan amount and dividing it by the construction cost.

Loan to Value (LTV) Ratio: Compares the proposed loan amount to the appraised value of the completed project.  (Loan amount divided by appraised value)

Maturity: The date the final payment of a loan is due.

Private lenders: Individuals or companies that lend to real estate investors and developers. Finding the right private lender can be tough – here are five qualities to look for in a private lender.

Proof of funds: A document or bank statement proving that a person has the financial ability to perform a transaction.

Real estate broker: Someone who acts as an intermediary to facilitate real estate transactions. In the case of a hard money loan transaction, they gather important information from the borrower such as income, employment documentation, and credit reports to assess how much the borrower can afford.

Real estate investor: Someone who purchases properties with the goal of making a profit, either through renting or reselling.

Refinance: Replacing an old loan with a new one. Typically, people refinance to take advantage of a lower interest rate, but can also refinance when an old loan becomes due.

Scope of Work: An outline of all the renovations scheduled to be completed before the property is sold, including their estimated costs.

Short Sale: A situation when a seller is selling their property for less than they owe on their loan. A bank or lender must approve the sale at the lower price.

Soft costs: Non-construction costs such as legal, financing, architects, etc. required for the project.

Title: Proof of ownership on a real estate investment property.

Turnaround time: The amount of time from when an investment property is purchased to when it is sold.

Underwriting: The assessment of how much risk a lender will take on for an investment property. Underwriters will verify the borrower’s income, assets, debt, and property details before approving a loan. Hard money and private money underwriters are typically more concerned with the property’s value than the borrower’s credit history.