In this series of articles (“Bank Turndowns”), we explore why borrowers are turned down by their bank for a loan, and how they can get approved by another lender. To access all the volumes in this series, go to our “Series” page here.
If you are looking for a commercial construction loan, it can be challenging to convince your bank to hit the “approval” button. From the bank’s perspective, commercial construction lending is particularly risky due to various factors:
- With labor and material costs increasing on construction projects, the bank needs assurance that you will stay within your budget. (According to a 2018 survey of top construction lenders in the United States, almost two-thirds of responders saw projects running over budget.)
- The bank needs a firm understanding of your completion schedule. (According to the same 2018 survey, 87% of construction lenders saw their projects running behind schedule.)
- The bank also needs to make sure that you are using a reliable contractor and quality construction resources. (The 2018 survey revealed that 77.5% of construction lenders experienced frequent material and labor shortages.)
In short, commercial construction lending continues to be tight as banks are slow to lend. However, if you are looking for a commercial construction loan and were turned down by your bank, here is the good news: While the big banks may be pulling back on construction lending, other lending institutions are not.
According to a 2019 report by the Construction Lender Risk Management Roundtable, smaller regional and local banks, as well as alternative lenders, are stealing back market share in construction lending.
Therefore, do not be discouraged if you were turned down by your bank for a commercial construction loan. We highlight some loan programs being offered by alternative lenders that could lead you on the path to successfully getting approved for a construction loan.
Obtain a construction loan guaranteed by the U.S. Small Business Administration (SBA)
The hallmarks of SBA loans are relatively low interest rates and long repayment terms. To qualify for an SBA loan, the borrower must meet several requirements, including:
- The business must be a for-profit business that does not exceed $15 million in tangible net worth, and does not have an average net income over $5 million for two full fiscal years;
- The business must be able to repay the loan based on projected operating cash flow; and
- The property in question must be at least 51% owner-occupied.
When it comes to commercial construction loans, two SBA loan programs stand out:
SBA 504 loan program
- The loan funds can be used to build new facilities (as well as modernize, renovate or convert existing facilities).
- The maximum loan amount is around $14 million.
- The down payment is usually 10% (but 15% if new business).
- The terms range from 10 to 25 years with a fixed rate.
SBA 7(a) loan program
- Unlike 504 loans, 7(a) loans have a more general purpose and can be used for construction, as well as other business purposes such as renovation and working capital.
- The terms are similar to 504 loans, except the maximum loan amount is $5 million.
- Also, the interest rate is tied to the prime rate (e.g., for loans 7 years or longer for over $50,000, the maximum interest rate is prime + 2.75%).
Obtain a conventional construction loan
For companies that do not qualify for government-backed SBA loans, conventional loans may still be a possibility. Even though big banks may be tightening up on commercial construction lending, smaller banks (local and regional banks) tend to have a bigger appetite to take on the higher risks associated with these loans.
According to a 2019 report by the Construction Lender Risk Management Roundtable, “In terms of share of the overall construction lending pie, the regional/local banks have been on a roll. Back in 2015, regional and community banks accounted for 23% of the total, rising to 33% in the first half of 2018 and 37% for 2017 as a whole.”
Rate and repayment terms vary, but business owners with good credit can expect to make a 20% to 30% down payment.
Obtain a hard money construction loan
This is typically a good option for businesses that cannot qualify for SBA loans or conventional loans due to a variety of reasons, including low value of collateral, limited documentation, or low credit scores.
For hard money loans (often referred to as “private money loans” or “bridge loans”), private lenders focus almost exclusively on the value of the property being used as collateral, not on the creditworthiness of the borrower.
Interest rates on hard money loans are usually higher than the rates for SBA and conventional loans.
However, the tradeoff is a relatively easier application process with less required paperwork and quicker time to close.
Here is just one example of a hard money commercial construction loan program:
- Loan amount: $150,000 to $15 million
- Maximum loan to cost: 90%
- Maximum loan to value: 70%
- Loan term: 12-month, interest only, no prepayment penalty
- Close in as little as 7 to 10 business days
- No interest charged on undrawn funds
The takeaway here is, despite the inherent risks associated with commercial construction projects, it is still possible to find a lender with the right risk appetite that is willing to approve your business for a construction loan. A mortgage broker can help you find the needle in the haystack and match you with the best lender for your commercial construction needs.
Continue exploring our “Bank Turndowns” series:
To access all the volumes in this series, go to our “Series” page here.
David A. Krebs is a licensed mortgage broker offering commercial and residential loan programs beyond your regular bank. Call us at 321-239-2781, click here to submit a message, or click here to book a free consultation.