Commercial Construction Lending Simplified

Permit delays, scheduling snafus, supply chain issues, and contractor disputes…if you haven’t experienced any of these, you haven’t been in commercial real estate construction for long. Even the best-laid plans can go awry, and dealing with those setbacks onsite is bad enough. But if you’re not working with the right lender, you might add a few more problems to your to-do list. 

It’s always best to prevent problems from happening in the first place. And while construction and renovation projects will always come with challenges, the right financing from the right lender can save you more headaches down the road. This blog will explore the basics of commercial construction lending, provide some insider tips, and explain how the right lender can be your saving grace in an otherwise challenging industry.

What is a commercial construction loan?

A commercial construction loan is a short-term loan designed for construction companies, developers, or builders to finance the construction or renovation of a commercial building. This loan may also be used by other borrowers as a stop-gap measure while a long-term financing solution is being pursued. Its draw schedule (contractor payment plan) helps pay each contractor and subcontractor on a schedule as their work is completed and can keep your project moving forward.

At Stearns Bank, we frequently partner with borrowers and developers on projects like multi-family properties, affordable housing, medical and business office space, industrial buildings, retail spaces, storage units, and more. 

What can the funds be used for?

The funds can be used for a variety of things, but the most common uses of funds include the following:

• Payroll and other operating expenses
• Materials
• Purchasing land
• Land development
• Purchasing or leasing new equipment
• Renovating an existing commercial real estate property
• Cash reserves to assist with competitive bidding processes

Could a commercial construction loan help your business?

You won’t need a commercial construction loan if you’re planning to purchase an existing building and move in as-is. However, if the site requires renovations or you need to build an entirely new space, applying for a commercial construction loan is probably your next step unless you have cash reserves that exceed the estimated costs of a significant construction project. 

Of course, even the most carefully budgeted project could hit a major snag anytime. So even if you have enough cash to cover foreseeable expenses, it’s often helpful to partner with a trusted lending partner to mitigate any unpleasant surprises and ensure your building project can be completed free of liens and covenants.

Additionally, working with a trusted lender could help your project avoid legal issues and save you a tremendous amount of time. Payment disputes are pretty common and represent a significant threat to developers: throughout North America, the average dispute is valued at $18.8 million and takes 17.6 months to resolve. A skilled lender can help you with your budget and ensure that the money drawn from your loan gets to the right hands on time, with signed state-specific lien waivers to prove it.  

Keeping your equipment up to date can do more than turn a potential liability into an anticipated, manageable business expense. Depending on your business and its financial situation, a large equipment purchase could help you save money on your taxes. Before making a big equipment purchase, we suggest consulting with your business’ tax professional to optimize any tax-saving advantages. 

How commercial construction loans work

With most loans, the borrower receives the total amount at closing. Commercial construction loans will release the funds according to a draw schedule that identifies payment distribution at various milestones outlined in the loan documentation. For example, the initial draw might be intended for land purchase, and another draw might happen after the foundation work is completed. Often, an inspector will confirm that a milestone has been reached before releasing more funds. 

The draw schedule helps ensure that work is completed on time and that the borrower only pays interest on the funds that have been drawn off the loan. If your loan is for $1 million, but you’ve only received $200,000 to date, you’ll only pay interest on the $200,000. Lenders can also structure your loan to include an interest-only period. Then you can either pay off the principal in one lump sum or receive a commercial mortgage for the property and use the mortgage to pay back the initial construction loan.

Longer-term loan options through the U.S. Small Business Administration (SBA) are also available. But don’t worry — you don’t need to become an expert in all aspects of commercial construction lending. If you work with a highly skilled lender, they’ll be able to recommend the best type of loan or loans for your business and help guide you through the process.

Interest rates, down payments, and fees

Your interest rate will depend on several factors, including credit score, the current market, and the lender you use. Banks typically have lower interest rates than hard money lenders. However, generally speaking, there are both fixed and variable-rate loans, with rates typically running between 4% and 15%. Fees will also vary, but you might expect to pay origination fees for conventional loans, SBA guarantee fees for SBA 7a and 504 loans as well as USDA B & I loans, processing fees, documentation fees, project review fees, and fund control fees. Down payments are typically required and range from 10% to 40% of the total cost.

What services are included in your lending agreement?

No one likes fees. But at Stearns Bank, you’re actually getting quite a bit of hard work for your money, and it’s done by real people who will be with you throughout the entire construction process. For every project, our team will begin with a full budget and contractor review and provide draws, monthly budget reviews, change orders, and other management services.

Additionally, depending on your project, our work will include the following: 

1. An upfront review

• Source & Use budget analysis 
• Initial budget assessment 
• Contractor due diligence and approval

2. Monthly reviews

• Monthly budget assessment
• Retainage monitoring/retainage release to sub-contractors 
• Response to change orders
• Contractor collaboration on backup for all stored materials
• Collection of state-specific waivers
• Inspection reporting
• Title, lien, and tax updates
• Second file review to confirm a balanced budget
• Final sign-off to fund the draw
• Wiring of funds to the contractor
• Soft cost payments, directly and to other vendors

3. An end-of-year project review

• Certificate of occupancy
• End-of-year 1099 reporting sent to the vendor and IRS

Is your business eligible for a commercial construction loan?

Not all construction projects are eligible for a commercial construction loan. To determine your eligibility, your lender will consider the nature and scope of the project, the ability to repay the loan, your experience, credit score, business credit score, income, and current debt. You’ll also need to provide your lender with detailed construction plans so they can assess and help you minimize risk.

Common types of commercial construction loans

Finding the right lender is essential, as they will be key to helping your project stay on track and avoiding common commercial construction pitfalls. If you’ve been in commercial construction for some time, you may have had the unfortunate experience of working with a lender who didn’t “speak” construction. At Stearns Bank, our lending team understands the construction process very well and will help guide you to the right loan to help your business in the short and long term.

SBA CDC/504 or SBA 7(a) Loan Programs

These Small Business Administration loans will fund projects up to $5 million, and it’s a popular choice for borrowers and lenders – expect low down payments and competitive rates. As an SBA Preferred Lender, Stearns Bank is empowered to approve these loans in-house and provide high-level guidance throughout the approval and closing process.

Bank loans

Rates, repayment terms, and down payment requirements will vary depending on your past and present financial circumstances, the market, and the lender you choose. So don’t make the common assumption that banks are all the same. They’re not, and the service, rates, and relationship that a lender offers you may vary more than you think from one lender to another.

Mezzanine loans

This type of loan can get confusing quickly, but its name holds a few clues. A mezzanine is a floor between two stories that helps connect them. Mezzanine financing is an in-between loan, bridging debt financing and equity financing. It’s secured with stock, so the lender can still safely fund higher-risk projects.

Finding the best commercial construction lender

You already know to expect the unexpected when it comes to any new commercial construction or renovation project. The right lender will know your business almost as well as you do, so they can identify any risks in your construction plan and help you avoid potential problems before they affect your budget and timeline. That’s why Stearns Bank has a dedicated construction lending team with decades of experience in the industry.

Stearns Bank also has a national reach and works with you to reapprove changing details, so you’re not stuck to a budget and a timeline that no longer works for you. And if the best loan for you is an SBA loan, the Stearns Bank team can approve these loans in-house, helping you save time and streamline the entire loan process.

Our team will also be with you through the life of your loan and will answer the phone on the very first ring. When you’re working with rapidly changing circumstances, and you need to talk to your lender, it’s nice to know that your team will know you by name, understand your project down to the fine details, and answer questions and offer solutions quickly.

Choosing a lender may seem like the least significant part of the process, but for many of our clients, our responsiveness and “pro-closing” approach have been vital to turning even the most potentially frustrating projects into rewarding and memorable experiences.