Understanding Real Estate Development Financing
Real estate land development involves many activities such as demolishing existing buildings and reconstructing, expanding an existing property, restoring run-down facilities and purchasing a piece of land to build a commercial complex. If you’re a developer, you’ll most likely require some real estate development financing, irrespective of the scope of the project. Mostly, developers secure this funding from a real estate development loan. Luckily, this guide will cover everything you need to know about how real estate development financing works.
There are four general categories of loans:
- Acquisition loan – This is a loan meant to finance the buying of raw land
- Development loan – This is used to make certain improvements such as building running water lines, building roads, and leveling that are required to turn undeveloped land into a building site
- (A&D) Acquisition and development loan – A combined loan meant for purchasing the land and building the property.
- Construction loan – Used to finance the construction or restoration of a real estate project. Unlike the other alternative loans, a construction loan allows the developer to receive the cash in monthly draws while development continues instead of a single lump sum at the start of the project. Meanwhile, the more you draw out more cash, the more the monthly loan payments.
What Financing Is Required?
Usually, real estate development financing comprises of two types of loans, short-term loan and long-term loan. With the short-term construction loan, it’s meant to finance the construction, as well as, lease-up the project’s phases. Once the construction is done, there is stable income and the most suitable market level of occupancy is achieved, a long-term loan (mostly referred to as take-out or permanent loans) is secured to cater for the construction loan.
If you’re a developer who happens not to have the relevant experience needed in real estate land development or perhaps you don’t have a solid credit history, then it can be a bit challenging to receive long-term financing. In such a case, a short-term interim loan (often referred to as a mini-perm loan or a bridge loan), can be an option. These interim loans bring together short and long-term financing, and they mostly take between three to five years, which is enough time that a developer requires to build a solid credit history. In some cases, a financial company merges short-term and long-term financing to form one package. These combined real estate development loans are referred to as construction-to-perm loans or construction/mini-perm loans.
Sources of Financing
Mostly banks, particularly regional and community banks since they have better control of the local market conditions and developers are the key lending source for these development loans. More administration and monthly draws are needed for construction loans; this makes banks the leading providers of these types of loans since they usually have the infrastructure required. Other sources of financing consist of finance companies (like Neal Business Funding), credit unions, private equity funds, mortgage real estate investment trusts (REITs), life insurance companies, and pension funds.
Commercial Real Estate Financing
Investors and entrepreneurs can find out great opportunities in the market. However, they are often tied down with the complexities that come with receiving financing for particular real estate transactions. With me as your financial liaison, Neal Business Funding can bridge the gap and assist you in becoming successful in the commercial real estate market. Our experienced team can provide you with assistance so that you can prevent turning the debt financing process into a frustrating and complicated process.
Various financing options rely on the dollar amount involved, interest rates, the amount of funds invested, and the debt obligation duration. Our financial advisers at Neal Business Funding are experts in analyzing these different factors and obtaining the most suitable commercial real estate financing package for every client that’s interested in real estate development or property investment; all thanks to our extensive experience across a wide range of sectors such as office, industrial, multi-family, residential ,retail, and medical.
Even though acquiring a commercial real estate can feel rewarding, it doesn’t take much time to find out that the world of commercial property finance can seem somewhat confusing. Luckily, the information provided below will assist you in finding the money you need to fund your investment.
Types of Commercial Loans Available
Typically, buyers receive the money to acquire or build commercial properties via a commercial real estate mortgage. All these loans can be issued by banks, insurance companies, pension funds, private investors, and the U.S. Small Business Administration. Commercial real estate financing loans come in a variety of types:
- Property development loan – This is a short-term loan used for major renovation projects or large-scale new constructions.
- Commercial mortgage loan – This is secured by commercial properties like an office building, apartment complex, or a retail outlet.
- Bridge loan – This is a short-term loan for bridging the gap until you’re able to secure a long-term loan.
- Portfolio loans – These are long-term loans meant for investors who have multiple properties. Usually, these multiple loans are rolled into a single loan.
The time duration needed to secure a loan relies on a number of factors such as the type of project, how well-formulated the plan is, the sponsorship of the project, and the overall market conditions. Also, the loan approval’s timing highly relies on your lender. It can take most financial institutions up to two months to approve your loan since there are commercial real estate requirements that they have to adhere to.
What Is the Length of Commercial Real Estate Loans?
The time it takes for commercial real estate finance loans varies from a few months to almost 40 years; however, the average lies between five and seven years. The amortization period is mostly much longer to match more closely the life of the project. For instance, a particular loan might be extended for eight years and have an amortization period of 40 years. In such a case, you will be required to make regular monthly payments, which comprises of principal and interest, for eight years; with the amount of payment depending on the principal incurred over forty years. When eight years are over, you are allowed to make one last balloon payment of the specific principal balance due. If you don’t have the money to make the specific balloon payment, you will be required to refinance your loan with your present lender or apply for an alternative loan elsewhere. Private lenders offer short-term loans that usually allow you more time to stabilize the income stream of a project so that you can be in a position to refinance later with a more traditional lender.
Commercial Loan Rates
Commercial real estate loans have a wide range of interest rates that vary based on the project’s type, the amount borrowed, repayment duration, sponsor support, availability of the funding source, and the volatility of the market. Private investors offer loan interest rates that are higher compared to conventional loans. The rate is high when you have a low credit score while a large down payment lowers the rate. Generally, interest rates are higher if the loan repayment period is more extended, and vice versa.
Apart from the interest rate charged for the commercial real estate loans, there are a lot of other costs, and fees included such as documentary stamp taxes, title insurance, survey, appraisals, and origination, to mention a few, all of which are combined to the overall cost of the loan. In some cases, lenders will also include a prepayment fee that’s meant for early payment of the loan. Additionally, they might also require you to issue periodic financial statements or adhere to certain financial criteria.
What Are the Qualifications of a Commercial Loan?
To get approved for some commercial property finance, the type of property you wish to acquire plays a significant role. No matter which lender you choose, however, he or she will expect to be repaid. All lenders have their commercial real estate loan requirements. Yet, when assessing a commercial real estate mortgage, there’re a few factors that lenders consider:
- The buyer should have at least 10% down payment
- Collateral – 65% to 80% loan-to-value ratio range for conventional lenders, 50% to 75% for private lenders, and up to 90% for government-backed loans
- Creditworthiness – The buyer should have a minimum credit score of 680 and minimum personal liquidity of 15% from the loan amount
- The ability to repay – The buyer should have a debt-service coverage ratio of more than 1.25
You will need to be ready to present both your financial statements and income tax returns for the past three to five years. For more information and expert advice, solicit the assistance of a financial partner like Neal Business Funding. We can assist you in finding the most suitable real estate development financing option for your particular project by working hand in hand with professional lenders to acquire the best deal possible. Get in touch with us right away to learn more.