Garry Barnes is a director of PW Partners Consultancy. He’s
a former bank CEO and president who currently serves on
the board of directors of Holladay Bank & Trust in Salt Lake
City. He taught at the university level, is a writer and lecturer
on banking and real estate matters, served on the U.S. Small
Business Administration’s National Advisory Council and was
an in-country consultant to the Central Bank of Russia. Reach
Barnes at (619) 791-9403 or email@example.com.
Continued on Page 40 >>
Construction Loan in Two Steps
Financing a building project requires short- and long-term thinking
By Garry Barnes
Typically, there are two different loan types required to finance a building project. Construction loans provide only temporary financingandareexpectedto
be paid off when the building is ready for occupancy.
At that point, either the balance on the construction
loan is paid in cash, or long-term financing is obtained.
The construction lender is in a vulnerable position if
the builder lacks the resources to pay off the loan balance or is unable to obtain long-term financing when
the building project is completed.
Consequently, some lenders will require a takeout
loan commitment from a permanent lender before
agreeing to lend on certain types of construction projects — such as office, warehouse or retail projects that
lack signed leases with major tenants or have failed to
achieved a certain level of space commitments. This
two-step process, of course, provides another opportunity for the mortgage broker to find a long-term lender.
Frequently, commercial mortgage brokers will successfully source and place a construction loan with
one of their lenders. If properly negotiated, a broker
will reserve the right to find a long-term loan to pay
off the construction loan when the project is completed.
Even better, the construction lender may have an interest in funding the long-term loan as well as the construction loan.
One potential issue with this arrangement is the
term lender may object to paying a second fee to
the mortgage broker for the same loan. If, however,
the broker bargains, documents and structures the
transaction properly, the one-time origination fee will
adequately compensate the broker for their time,
work and effort. A side benefit, but equally important,
is expanding a solid relationship with the lender,
which will open the door to future loan transactions
from the broker.
Experienced builders can normally obtain open-ended
construction financing without a permanent takeout
loan. Inexperienced builders will likely need to secure
a long-term takeout loan before they can obtain
construction financing, however. In the latter case,
the lender may require the buyer to obtain preapproval for a long-term loan before they will close on
the construction loan. All options discussed provide
opportunities for the mortgage broker.
Also, there are lenders that will not require a take-
out loan on a well-located project by an experienced
developer or investor, assuming the construction lender
feels comfortable that the originating broker can
readily find permanent financing when the project
is finished. The broker and construction lender know
the full market value of the project is not realized until
construction is completed and income is stabilized.
In one scenario, the borrower secures a construction
loan, and when the construction project is completed
and reaches stabilized occupancy as defined in the long-term lending agreement, the borrower then obtains a
permanent loan through another broker-arranged lender that is used to pay off the construction loan. This is the
two-loan approach and the advantage is that the buyer
and the mortgage broker retain the flexibility to negotiate the best terms available on the permanent loan.