The Basics Of Construction Financing -A Primer Part 2
How To Secure financing And Prepare Documentation For Your Lenders
I like to say that there are no secrets that can be kept from the money. Disclose everything up front about your construction loan because your lender will find it in during the due diligence process. The world of finance is driven by fees. The lender wants to give you money, they want to push out and lend as much money as possible. The problem is that each lender or different construction financing loan has its own underwriting criteria. The lender was given permission to loan you money based on that criteria. if the lender can get your loan to fit into that “underwriting” box, they will. Remember the lender wants to lend you your construction loan. Help give them the ammo to make it happen.
At CambridgeHomeLoan.com we underwrite your construction loan and then place it with the proper wholesale source or correspondent line to be as sure as possible that your loan closes. There are always items that come up along the way on your credit, in your background and on your project. Having underwriting that be flexible and account for those unexpected items is the key to your project coming to fruition.
To prepare your documentation for your construction financing start early so when the time comes you are not only educated in the process but organized in your paperwork. You should anticipate constant communication with your lender. Once you have a clear project plan and keep your prospective lender in the loop as your project progresses. Your lender will want to see your pro forma for your construction project that shows the anticipated income and expenses not only for the construction but for up to 10 years following stabilization. The pro forma or income/expense must include a realistic estimate of the lease-up period — i.e. the time it’ll take for your property to achieve stabilization and post stabilization.
BUILDING THE RIGHT TEAM AND LINING UP THE RIGHT TENANTS
Lenders perceive less risk when the right team is involved. Lenders are all about the warm and fuzzy feeling that the project will succeed. Your construction loan project will either perfectly fit into your lenders underwriting or more likely will have to sell this project to his loan committee or at the very least request what internally is known as exceptions along the way. Your project is much easier to get over any of those issues along the way if you have disclosed all of the parties involved and if all of the parties involved are experienced and profession. A high net worth from the principals never hurts but even more importantly today is a healthy FICO score and a good track record.
It’s always easier to get a loan for an owner-occupied, single-tenant or multi tenanted building than for a non-owner occupied facility. Why? Because there’s a clear plan for how your property will be used and who will pay the bills.
For multi-tenant facilities, having tenants lined up makes it easier to procure financing. Lenders on multi-tenant retail projects may require pre-leasing to one or more anchor tenants before providing financing. Banks may not make this type of loan at all until a specific percentage (50 percent, for example) of the property is leased to reputable, good-credit tenants. In other cases it is about having good tenants, healthy reserves and a good net operating income. Retailers and potential tenants are everywhere. Put a package together early and as soon as your project is under way start contacting realtors, brokers and potential lessors with your leasing package. I used this strategy when i purchased or arbitraged commercial properties and it worked amazingly well. We would tie up a property, retail, office, miixed use, etc. go for financing and at the same time be contacting tenants. In almost every case we were able to procure a tenant or two prior to closing on the financing. This made the lenders job much easier and increased the value of our property even before closing on it.
TYPES OF FINANCING AVAILABLE
Different Types of Construction Financing Sources
There are always multiple options for financing any real estate construction project. Some of those financing sources include Private Financing, Federal Programs and various state opportunities. For most construction projects private funding or wholesale construction loans through an agent are the easiest to obtain.
Bank Loans – Bank loans may be a good fit for smaller construction loan, under $3 million dollars A bank loan may be attractive if all of your documentation is perfect but banks have very little flexibility when something comes up in due diligence that is out of the box. If you can get through a local lenders underwriting, their rates are typically low.
CONSTRUCTION FINANCING WITH BANKS
Banks that specialize in construction financing typically have teams that have extensive knowledge of construction and can make great advisors during your process. Again their underwriting is stringent.
At CambridgeHomeLoan.com we see a lot of construction loan business from investors and developers that fell out of due diligence with their banks at the last minute and need urgent financing. Be aware that when working with a bank you should have enough time on your contract to allow for having to change directions at the 9th hour.
SPEAK TO A CONSTRUCTION LENDING PRO!
SBA LOANS SMALL BUSINESS ADMINISTRATION LOANS.
The SBA offers its 504 Loan program (commercial construction loan) to forprofit businesses that occupy their own properties. It’s available to small and mid-sized businesses for projects of up to $20 million. The SBA Loan allows you to preserve capital, maximize tax deductions and control overhead, as you only need to put 10 percent down and may potentially use land as equity. It offers a long-term amortization (25 years for first loan, 20 years for second). The way you use your space is limited though. You can only lease up to 40 percent of a newly constructed space to another business and up to 49 percent of an existing building you upgrade.
TAX INCREMENT FINANCING
Throughout the U.S., run-down, vacant areas and facilities reduce property values. Communities aim to raise property values and generate sales tax revenue by attracting
strategic investments in their area. One tool they use is Tax Increment Financing (TIF), a TAX INCREMENT = property tax value after development – property tax
value before development long-term tax incentive offered by a municipality (rural or urban). TIF has been used in 49 states (not Arizona) and has been around since the 1950s.
Through TIF programs, owners pay the up-front costs of a project, but as the property value of the facility and the surrounding TIF area rise, the increases in property tax value are actually paid to the owner in the form of tax increments. A tax increment is the difference between the property tax value of a property before and after development.
Each year for a set term (usually not more than 15 years), you’ll a receive tax increment payment. The more you raise the property value, the more money you get back.
HOW TO GET A TIF
To get a TIF, you need to work with a Community Redevelopment Authority (CRA) and show that your project increases the value, not only of your development, but also of the surrounding properties within the TIF area. And you need to show that your project will spur additional investment in the community. A TIF has to pass the “but for” rule, which states “development wouldn’t happen but for public help.” It’s a mechanism to make impossible projects financially feasible. To get a TIF, you’ll likely need a specialty consultant and must meet a range of requirements.
DRAWBACKS OF TIF
Securing TIFs is one of the more difficult and longest of the lending processes requiring public review of your project. First off your investment property must be located in a designated TIF district, this option alone limits the number of projects that are available. And the municipality can use TIF money for specific purposes only (depending on the type of TIF district). TIF funding usually involves some type of infrastructure improvements, which makes it appealing to the public such as clearing land, installing storm water retention, extending utilities and services or a similar project. While a TIF may reduce the initial cost of construction, the payoff may not come for a period of time. There is some risk involved, as your property must achieve a higher value. As you must pay for the project up-front, you may still need to secure initial project financing.
FEDERAL PROGRAMS FOR SPECIALIZED PROJECTS
The federal government has created a range of loan and grant programs for specific project types. You can find more information on these programs at govloans.gov.
DRAWBACKS OF FEDERAL FUNDING
Federal programs are dependent on annual funding being there when you are ready to ve funded. Projects have to compete for this funding, so it isn’t guaranteed. Also, timing becomes critical. If you miss the funding round, you may have to wait up to a year or more, potentially jeopardizing your project timeline. Most federal funding programs are so specialized you’ll need to hire expert consultants to attain them. These consultants come with their own fees, adding soft costs to your project.
Each state offers its own funding programs. Depending on where you build, you may be able to secure funding, so it’s worth researching what’s available at the state level. These loans also have many of the same pitfalls as the federal loan programs. They may have funding today or even when you start your submission process and then may run out of funds during your underwriting process. The program may not get renewed and you may have to look elsewhere for funding. Do your due diligence and speak with the department directly to understand the funding source and how it is replenished.
CONSTRUCTION FINANCING MADE EASY
PRIVATE EQUITY & BROKERS FOR CONSTRUCTION FINANCING
The most popular and most often successful form of construction financing stems from Private Equity. Private Equity construction loans encompass a whole range of financing options for the investor. CambridgeHomeLoan.com has 11 sources of wholesale construction lending lines that consist of private equity. We are direct lenders ourselves, have wholesale lending lines, act as brokers and originators. All of these scenarios fall under the Private Equity resource. All that the term Private Equity means in this case is that the funds are backed by private sources that have given underwriting authority to structure and lend their funds.
The private investors receive greater than bank interest secured by real estate. The lender has more flexibility to overcome “exceptions” to the underwriting and get your loan closed. These loans do not have a committee and your loan officer has way more flexibility than a bank to help you get your loan closed. These loans can also be closed in 5-7 days vs a bank loan that can take months to close.
The best source of financing for construction.
5-7 Day Close – No Funding Limits