Borrowers face a unique set of challenges when it comes to securing a loan for their commercial real estate (CRE) projects.

Arranging and structuring debt, equity, mezzanine, and C-PACE financing for hotels and multifamily real estate requires knowledge and skill.

Given the complex nature of CRE deals, how do you navigate the market to secure the best loan for your business? This article will guide you through the nuances of commercial construction financing.

Understanding Commercial Construction Financing

The inherent complexities of commercial construction financing create the perception of a barrier to entry for many borrowers. The reality is that these income-producing properties can be very lucrative additions to any portfolio… you just need to know how to negotiate the best deal for your business.

Among the most common types of commercial real estate are multifamily residential, senior residence workforce housing, condominium or hotel construction.

A commercial construction loan is used to finance the costs associated with the construction or renovation of one of the aforementioned properties. Mortgages for these buildings are typically secured by liens on your intended property. Loan terms typically involve borrowers providing a 20% to 25% down payment.

Similar to home mortgages, banks and lending institutions are actively involved with commercial loans. Generally speaking, a middle-market CRE is defined by a transaction price of approximately $2 to $50 million. The price point qualifies a borrower for special lending programs such as SBA loans, which can go up to as high as $10 million.

Commercial construction loans typically range from five years or fewer to 20 years, with the amortization period at times greater than the term of the loan itself.

Commercial loan-to-value (LTV) ratios generally fall in the 75% to 85% range. For example, a raw land deal may see an LTV on the lower end, perhaps even at 65%, while an LTV of 80% might be more acceptable for multifamily residential.

When an individual or entity considers the benefits of purchasing a commercial space – leasing out units, collecting rent from businesses or residents that inhabit the property – the bigger picture is one that often appears profitable. 

Here's how to ensure the terms of the deal will set your business up for success.

How to Secure Commercial Construction Financing

To secure the best terms for your CRE loan, lenders will consider the collateral, your creditworthiness (or the creditworthiness of the entity you represent, including principals/owners), three to five years' worth of financial statements and tax returns and financial ratios such as the LTV and debt-service coverage ratio (DSCR).

Put simply, a coverage ratio determines your ability to service the debt and meet your obligations, such as interest payments or dividends. The debt-service coverage ratio of your loan compares a property's annual net operating income (NOI) to the annual mortgage debt service, which includes both principal and interest. This is calculated by dividing the NOI by the annual service debt.

When negotiating your commercial construction loan, it is important to have precise and current records. Given the unique capital needs and complex nature of the deal, most national banks aren't willing or able to finance construction deals. In the past forty years, three commercial real estate crashes – the S&L Crisis, the Dot-Com Meltdown and the Great Recession – have resulted in a CRE decline roughly 45% each time. This has led to hesitancy on the part of national banks to consider commercial real estate loans.

Debt and equity-structured financing, on the other hand, is suited to borrowers with complex funding deals. Structured financing is typically non-transferable, ensuring that debt cannot be moved between different instruments the way a conventional bank loan can.

This is why dealing with direct debt and equity lenders with their own balance sheet is the best path to secure CRE financing.

Commercial Construction Financing Tips and Best Practices

There are many challenges and potential pitfalls associated with securing commercial construction project financing. To help you avoid them, here are the types of financing to consider when making your application:

  • Bridge loans hold the borrower's debt service for a set period while they transition to a different financial situation. Some bridge loans are obtained under the expectation of refinancing into a fixed-rate mortgage after the construction is completed and cash flow begins to come in via property rentals and tenant payments. Bridge loans typically offer up to 12 months of payment-free financing at a higher interest rate when compared to conventional loans.
  • Mezzanine financing can be structured in a variety of ways, involving both debt and equity arrangements. Mezzanine financing operates like an add-on to the borrower's main source of capital. As a result of being a higher-risk form of financing, mezzanine instruments come with higher costs.
  • Convertible debt involves both the lender and borrower arranging a loan that can be converted to equity down the road, provided that certain conditions are met.
  • Participating debt is an attractive option if you expect that your construction project will attract dependable, financially sound tenants interested in long-term leases. In these situations, the capital lender will finance the project in return for interest payments or cash flow generated by the property.
  • Preferred equity financing involves the capital or main source investing in the commercial property deal. The preferred equity investor receives a fixed return in advance of the distributions made to other shared or common investors.
  • Junior debt is a secondary source of capital added to the primary source or senior loan. You may be interested in adding junior loans if you need to borrow more than the amount legally permitted for the senior loan itself. You'll pay the junior loan only after paying off the senior debt in full.
  • C-PACE Financing is a tool that can finance clean energy efficiency and renewable energy improvements on commercial property. C-PACE uses borrowed capital to pay for the upfront costs associated with renewable energy or energy efficiency considerations for the property. Borrowed C-PACE capital is repaid over time via a voluntary tax.

Commercial loans involve multiple documents, forms, authorizations and agreements. Before closing a debt or equity loan deal, it is important to ensure that you avoid the more common pitfalls associated with CRE financing applications.

Shopping the deal across various lenders might seem an attractive idea, at first glance. After all, why settle on the first deal? When it comes to commercial real estate transactions, this type of thinking can prove detrimental to the successful acquisition of your ideal financing terms.

The world of commercial real estate lenders is smaller than you may realize – if the broker you're applying to catches wind that your deal has been shopped amongst multiple lenders, they may assume the proposal is in poor standing.

Another important factor to consider is ensuring that you have a line of sight into both the prepayment and penalty terms for your loan.

Prepayment restrictions on commercial construction project loans can be common. They are designed to preserve the lender's anticipated yield on a loan. If the investors settle your debt before your loan's maturity date, borrowers could be subject to penalties.

These are the four most common types of exit penalties associated with paying off a loan early:

  • Prepayment penalties for construction loans are the most common and are calculated by multiplying the current outstanding balance by a predetermined prepayment penalty rate.
  • Lockout penalties could apply if you, as the borrower, cannot pay off the loan before a specified period.
  • Interest guarantee ensures your lender is entitled to a specific amount of interest, regardless of whether or not your loan is paid off early.
  • Defeasance is the substitution of collateral leveraged in the deal. Instead of paying cash to the lender, you exchange new collateral instead of the original, agreed-upon loan collateral (for example, trading U.S. Treasury securities for cash). Although this can reduce some fees, it can substantially increase the risk of high penalties for changing the terms of the agreement.

While commercial construction financing allows for the acquisition of properties that can ensure business diversification, working with an intermediary who understands the terms and conditions of the deal is the best way to ensure your investment is a sound one.

Black Collie Capital Commercial Construction Financing Solutions

Black Collie Capital is a commercial real estate finance and advisory firm that specializes in arranging and structuring debt, equity, mezzanine and C-PACE financing for hotels and multifamily real estate on behalf of developers, investors and owners.

We understand the nuances that can expedite your financing application, and, by working only with direct lenders, we offer certainty that your deal is considered quickly and thoroughly. The advantage of working with direct lending institutions is that your deal is centrally housed and approved, rather than required to wait for the review and approval of different lending parties.

Black Collie Capital can reduce the friction and sticking points often associated with commercial estate deals. By dealing only with direct lenders, we can provide both consultative knowledge, advice and – most importantly – the certainty that your deal will receive the consideration it deserves.

What makes Black Collie Capital unique in the CRE market?

Here are the steps we take to ensure your deal is both attractive to lenders and lucrative for your business:

  • We assess your real estate capital and create a customized plan to help you access the right capital and funding solutions.
  • We offer real estate capital and investment advisory services that handle everything from analysis, deal structuring, underwriting and strategy for acquisition, construction and repositioning of your investment.
  • We right-size the information given to the quoting process. By sending the deal to the lender in parts, we keep the focus on the right information at the right time.
  • We stay with you. From the strategy planning session to the selection of a project manager for your completed construction project, Black Collie Capital stands beside you for every stage of your commercial real estate investment.

Don't be daunted by the complex nature of commercial real estate financing. Work with a strategic partner who will get the results you and your deal deserve. Contact us today and experience the Black Collie Capital difference.