In our last post, we discussed the various funding sources to start your project. In this post of the development overview series, we will explain the construction loan.
Once you have acquired the land, designed and obtained permits for your project, then you will be ready to move into the construction phase. With your completed plans, you can ask qualified general contractors to submit proposals. Once you’ve received the bids then you can apply for a construction loan from a bank. Some banks specialize in certain types of lending. For example, some banks will not lend to construct "for sale" residential condominiums and prefer "for lease" apartments. In any case, try to find a loan officer who specializes in the type of project you are doing.
The advantage of loans is that the interest rate will be lower than equity and therefore will improve project returns. The disadvantage of loans is that unlike equity they will require collateral and/or a guarantor. In the unlikely event that the project generates a loss and the collateral is not sufficient to pay back the loan & interest accrued (in default), then the banks will try to recoup their funds from the guarantor. This is called a recourse loan and is typical for most real estate projects. There are also nonrecourse loans where the banks will keep the collateral but will not seek out the guarantor for damages even if it does not cover the defaulted amount. However, we’ve only seen this for large real estate projects ($100 million or more).
In order to apply, you need to put together the following:
Borrower Information – The borrower is typically a Limited Liability Company (LLC) and will need to provide incorporation documents, IRS issuing Employer Identification Number (EIN), Statement of Information, etc.
Guarantor Information – Resume, personal financial statement (net worth, assets and liabilities), tax returns, bank statements, etc.
Project Information – Approved set of project plans, permits, project financials, detailed cost breakdown and pre-paid items with invoices and checks.
Land Information - Escrow closing statement, environmental and engineering studies
Contractor Information – Resume and license
Insurance Information – Project and construction insurance details
For your first project, be prepared for rejections. You may need to approach several banks before finding one that is willing to lend to you. You’re not alone as that was also our experience.