Commercial construction loans usually take the form of short-term finance which is granted to businesses looking to pursue a commercial construction or a redevelopment project without requiring the upfront capital required for the entire project’s completion.
Businesses may need a construction loan when:
- Erecting new buildings on land.
- Converting residential property to commercial property.
- Redeveloping purchased or rented commercial properties.
What Are The Advantages of Commercial Construction Loans?
Construction loans allow you to construct larger projects than your immediate cashflow would allow, also they enable you to easily seize opportunistic plots of land or properties before they’ve been acquired by someone else. Finally, acquiring additional funding from a commercial construction loan allows you to simultaneously undertake multiple projects across two or more sites.
Loans can be taken out either by contractors, developers or businesses and may cover smaller projects on smaller pieces of land or huge projects numbering hundreds or thousands of properties.
Commercial construction loans are usually taken out by SMEs or other smaller developers rather than large developers who will fund their projects using private equity firms.
This article will take a detailed look at commercial construction loans, the options available and where to look for them as well as any necessary prerequisite information you will require to secure loans and how best to prepare.
In the UK now, commercial construction loans have been largely deregulated and are subsequently offered by an array of financers:
- Community Banks – Community banks are non-profit cooperative credit unions that are run by members under a unique management structure and they have no shares or stakeholders. Community banks offer very competitive rates and banks like the Derbyshire Community Bank serve 1 million people whilst looking after over £1 billion in assets. Since community banks are hard-linked into the local community and the local geographies of the area where your project might be situated, they are in an adept position to offer advice and competitive rates that suit a project’s unique characteristics.
- Regional Banks – Regional banks and community banks are separated by fine lines in practical terms at least. The nature of these banks is similar in that they operate at community and regional level and they have unique ownership structures when compared to national commercial banks. Cambridge and Counties Bank is one of the UK’s largest regional banks and is well-known for their commercial construction loan lending and support of SMEs through advice schemes.
- Commercial Banks – Commercial banks are your big mainstream banks and lenders like Lloyds, Barclays and Halifax. They operate at a much higher level than community or regional banks and are often less acute in the ways they deal with smaller or niche commercial construction projects or developments. That said, for larger projects, they are straightforward to work with, can accurately weigh up factors and risk and offer various loans and financial products at appropriate rates for larger business construction projects.
Other financers have begun to offer construction loans including life insurance companies and speciality finance companies. When a business looks for a loan, it is sensible to look first to the locale to assess if there are lenders who specifically focus on assisting SMEs or business of your size before you widen your sights to include larger area lenders or more niche lenders.
Commercial construction projects range from short annexations of simple buildings to existing structures that take months to full-blown major-scale construction projects that take place over several years. Finance might have to cover one of two bases:
- Shorter-term: Covering construction up until the projected is marketed.
- Longer-term: When a project is finished to a point of market and value stability, the construction loan can be slowly removed by longer-term more attractive financing thus freeing up cash flow from your project.
Banks can offer bridge loans that are short in duration compared to longer-term permanent finance, e.g. a mortgage. This loan bridges the project between the stage of construction and the point it is refinanced on the permanent property market as a finished property. Businesses can then efficiently transition between more expensive short-term loans for construction before securing long-term fixed-rate mortgages to free up liquidity in their property. Bridging loans also build credit and operating history for the project to increase the likelihood of securing good lending rates in the future.
Bridging finance is also more liberally granted to first-timers and requires fewer project details to assess risk. So long as the lenders deem the risk is low, they’ll be happy to grant bridging finance without too much scrutiny. This means it is naturally limited to smaller projects that pose little risk to lenders.
Bridging Loan to Value (LTV): Around 75%.
Bridging Loan Interest Rates: Monthly, bridging loans may incur between 0.5% and 2% interest. Interest is added to the loan and repaid in capital at the end of the loan term – it is not paid monthly.
Extra Costs: Arrangement fees may total 2% of the loan total for smaller loans below £150,000 and lower than 2% for loans higher than this.
For larger loans with niche financial products tailored to your project, bridging loans are likely not suitable. Non-bridging development finance is more complex and nuanced but it allows for lower borrowing rates, higher sums of money and longer durations. Development loans are usually given in sums released upon completion of pre-arranged milestones, for example when the foundations are laid, walls and roofs are complete, electricity and water installed, etc.
Development Loan to Value (LTV): Around 70% to 80%.
Development Loan Interest: Added the loan monthly, interest ranges between 4% and 15% per annum depending on your project, experience and other financial factors.
Extra Costs: Facility and processing fees may cost around 1% of the total loan.
After choosing your preferred general loan type, the first step is choosing a lender and submitting a loan request. This will be quickly assessed as to whether it will be taken on for further scrutiny and approval. Bridging loans are easier to qualify for and will require you to submit fewer plans and documents, ideal for small projects and first-time developers.
The lenders will overview your request and make a decision over whether to forge on with the underwriting process where project details as well as the projections of the property’s value, gross development value (GDV), will likely be taken into account.
These will assist the lender in advising on the loan amount, rate and schedule as well as other niche clauses unique to the project.
Following these initial discussions, a timesheet for the loan application will be issued and agreed to by the borrower if the details are successfully accepted.
h2>What Details and Documents Will I Need?
Once again, the complexity of your loan’s underwriting process will vary based on whether you need shorter term straightforward bridge finance or a long-term development loan.
The underwriting process will evaluate all of the property’s details including construction. local, regional and national market dynamics and conditions will be evaluated to contextualise the development on multiple economic & geographic levels.
Factors assessed could include:
- The developers or contractors themselves and their reputation.
- The financial performance of any guarantors.
- The tax returns and financial statements of both the borrower and the guarantors where applicable.
The property construction schedule and performa may also be scrutinised alongside plans and costings, technical specifications and surveys.
Since commercial construction projects have no operating history, underwriting is more complex and thus the real estate proforma of the project is crucial. A real estate proforma indicates the cash flow projections for a real estate project.
The extent of the details you’ll have the provide will vary greatly on your experience, project details and many other economic factors and as such, when you reach loan stage, it’s highly advantageous to have already obtained planning permission.
Most development loan applications will be disregarded if you don’t have planning permission for obvious reasons – without it, the lender does not even know whether or not the project will be allowed to take place.
You’ll also need the services of surveyors who can analyse your project, land and construction ideas to relay them with local authorities where required and assist you in drafting up finalised plans alongside costings and timetables. It’s worth bearing in mind that the general construction ideation > planning permission > loan > construction process progression will vary with local authorities and lenders and that there is no one-size-fits-all approach.
Commercial development in many parts of the UK must meet unique criteria set out by local authorities. These screen developers to make sure proposed projects are compatible with the space that surrounds them. These local application processes are inherently linked to funding access.
One example is London’s Small Sites Small Builders project that put up a number of publicly owned sites for both residential and commercial redevelopment. This is an example of a property construction or development opportunity for which a business might want to secure a loan but also where funding is inherently linked to the local authority regulations.
The project itself has its own proforma and a detailed document of how the developer expects the project to unfold. This is both a quantitative and qualitative document; it needs to include:
- Numerical statistics and statements from costings and forecasts.
- Written accounts of why a developer thinks they’re suitable for the site.
The document is submitted to local authorities who will either green-light the plan and recommend it for finance, send it back for adjustment or decline it.
An application-style process like this is common in cities where the council want to ensure commercial developments add value and use to local communities.
Still, it’s always worth to considering your project in granular detail and a commercial chartered surveyor will help you do this.
Below is some key criteria for improving your chances of securing funding for your future commercial developments:
Summaries of Past Projects
Intrinsic to assessing risk is history. Small developers may not have a portfolio or history of past projects they’ve delivered either individually or as a joint venture. If present, this may include descriptions of how challenges and setbacks during construction were overcome.
Team and Contractors
To easily secure a commercial construction loan your building team need to be highly skilled and reliable. Also if your project includes niche features then contractors that are familiar with creating these will be required.
Your Building Proposition
This is the main body of your project statement and business plan. It needs to be as detailed as possible and should include:
- The dimensions of your property.
- The planned use (this will have been determined for planning permission).
- How the building will interact with the area (regional and community banks will be looking for great levels of detail here).
You’ll need to show when financial injections will be needed and what milestones you expect to complete with each block of money released from the loan. Also its worth highlighting how your time schedule could be threatened and strategies for overcoming any potential obstacles.
Financial and tax statements of the borrower and guarantors where applicable will need to be assessed alongside past financial performance. Your GDV will also have to be given and explained in detail. This figure is the most important factor, as it provides a prediction of the commercial buildings value for after the development has been completed.
Commercial construction loans may be simple and easy to organise for smaller projects that require short-term funding repayable from a property’s eventual market value but for large or niche projects, a more in-depth assessment will likely take place to overview the project in more granular detail.
In any construction loan application, by obtaining planning permission, a comprehensive survey of the land and the project you’ll be well prepared to start the application process.
When searching for lenders, consider your project location, size, purpose and scope. Mainstream lenders are not always the best option and since the loan market has diversified hugely in the UK in recent years, you will likely find far more options than you may have predicted. Many lenders provide advice and assistance for SMEs as well as progressive finance options going forward or bolt-ons to cover equipment, staff and security amongst other extra costs.
Commercial construction loans are borrowed to temporarily assist businesses in constructing or redeveloping properties on a commercial site. Not every developer will have the necessary capital upfront to build their project. Commercial property loans can ‘bridge’ the developer between construction and mortgaging an eventual completed property that releases value from the finished project to pay off the initial construction loan.
A variety of niche and mainstream lenders offer construction loans for both residential and commercial properties. The lenders you should approach first depend on your project. Smaller niche lenders who are specifically tailored to commercial developers may prove the best option for larger development loans whilst bridging loans are more generic and are offered by a wider array of lenders.
Always start by investigating local options. Local lenders will understand the area as well as any past developments that have taken place in it, helping them provide valuable assistance to SMEs and first-time developments. It’s not always just about the financial product itself but about the assistance that comes with it.
Interest varies chiefly with the project, loan value, risk of the project and loan duration. For construction projects that have highly detailed plans vetted by surveyors and accountants alongside robust GPVs and timetables, interest may be as low as 2% per annum for development loans or 0.5% a month for bridge loans.
Bridge loans are used in a variety of different circumstances but in construction and development, they typically describe a loan that provides the capital to build a commercial property to then be repaid from its eventual value or covered, ‘taken up,’ by longer-term funding options like mortgages.
Bridging loans are also granted quickly, often within 24 to 48 hours of an application for smaller loans below £150,000. Bridge loans are suitable for smaller loans on smaller projects and security comes in the form of the property itself which, upon its eventual construction, can be used to repay the loan and interest which is accrued over the loan period and paid at the end of the term and not monthly.
There are two broad types of loans available for commercial construction projects.
- Bridge Loan
- Development Loan
Generally speaking, bridge loans are more generic and for commercial property, they are more or less the same for residential property. They enable buyers to close in on an opportunity rapidly whilst obtaining the necessary funding to quickly get the project moving before paying off the loan and its interest payment when that project is completed and moving on to long-term finance.
Development loans are suitable for larger more complex projects, they’re a niche financial product that can provide large sums of money for large-scale projects. Development loans require far more to qualify such as a proven track history and development portfolio.