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NGExpert financial copywriter
Page written by Chris Godfrey. Last reviewed on November 27, 2024. Next review due October 1, 2025.
Building new commercial properties or making your current business premises larger can be costly, often running into the hundreds of thousands or even millions of dollars. Trying to cover this kind of expense out of working capital rarely makes sense, which is why most organizations take out a commercial real estate construction loan when they need to go big. But what exactly is a commercial construction loan and how can you get one? Let’s find out…
A commercial construction loan is a type of short-term business loan that organizations use to cover building or renovation costs, including land purchase, materials, and labor. These loans typically allow interest-only payments during the construction phase of a project, but costs can rise significantly once construction is complete.
Commercial construction loans usually work to a schedule that allows the phased drawdown of funds (loan disbursements) subject to the project meeting specific milestones. For example, a portion of the financing might be released only after a particular inspection is completed or the building’s foundations have been laid. During the construction phase, most lenders allow borrowers to only pay interest on the drawn amount, not the total loan sum. However, be aware that interest rates on construction loans tend to be higher than many other forms of business financing. Additionally, most lenders will only provide 70% to 90% of the value or cost of the project. This is known as the loan-to-value (LTV) or loan-to-cost (LTC) ratio.
Construction loans typically have short terms, with the full balance due upon project completion. If you can’t pay off the loan by then, you’ll usually need to refinance or obtain a commercial real estate loan. Some loans, known as “construction-to-permanent” loans, transition seamlessly into longer-term financing with the same lender, allowing continued payments over an extended period.
Commercial real estate construction loans can be used to:
As well as commercial construction loans, there are other ways to fund your commercial building project or pay for renovations:
Also known as ‘commercial real estate loans’, commercial real estate mortgages are typically the most economical way to buy commercial property and in some cases this type of financing can also cover construction costs. Commercial mortgages are long term – often up to 30 years – and often come with the lowest interest rates of any type of business financing. Some commercial mortgages may be obtained with down payments of 10% or less, while others may be available as interest only for a set number of years before reverting back to full amortization.
SBA 7a loans are provided by banks, credit unions and online lenders who are part of the federal Small Business Administration (SBA) lender network. Partially backed by the US Government, these loans can provide up to $5million to qualifying borrowers with repayment terms as long as 25 years. Some SBA lenders may be willing to provide 100% loans to buyers and developers of commercial property and to cover commercial construction costs. However, be aware that meeting the rules of eligibility for SBA loans can be tough. As well as an approval process that can take several months, organizations will typically need to have been in business for at least four years and have annual revenues over $180,000. Your personal FICO credit score will also need to be at least 680.
Buying big ticket machinery and equipment for your construction project can put a major dent in your cash flow, but equipment loans can pay for your new plant and machinery without causing financial stress. Equipment loans are ‘self-collateralizing’ – they use the asset you’re financing as security, similar to a car loan or a residential mortgage – so no added collateral is required. You use the equipment as you pay for it and the lender maintains a lien on the machinery. Once you pay the loan back, the lender releases the lien, and you own the equipment outright.
Alternatively, if you already own high-value machinery you could use it as collateral for a loan to pay for building construction or renovation costs. In this scenario, you get to keep and use the equipment, but the lender maintains a lien on the assets during the term of the loan. Once you pay the loan back, the lien is dissolved.
Term loans are the most common type of commercial loan and typically used for one-off investments where you know exactly how much cash you need. Use of funds is flexible with many business term loans. Use the cash to cover construction costs, or pay for materials, labor, plant and equipment. You receive a single, lump-sum cash injection and then pay it back in regular instalments over a fixed period of up to 25 years. Loans may be secured or unsecured.
Short-term financing to cover commercial construction costs will usually come in the form of a commercial bridge loan. These are flexible, short term business loans that organizations can use to cover a temporary shortfall in funding. Bridge loans can ‘bridge the gap’ between selling one property and buying another, cover construction and renovation costs, help you to complete a project, or pay for construction expenses while you wait for a long-term loan to fund.
Commercial construction loans are priced individually, with each transaction carrying a custom cost. However, you should expect your construction loan to incur a range of fees, plus interest based on your credit profile and the conditions of the loan (see below).
Interest rates on commercial real estate construction loans vary according to the type of project, the financial strength of the borrower, the value of the collateral, the proposed term of the loan and the sum requested.
Commercial real estate construction loans can be obtained by approaching banks, credit unions and online lenders one by one, or you could use the services of a loan marketplace that will immediately introduce you to a choice of commercial construction loans from different lenders. Some marketplace platforms can also give you advice and help you with the application process. This can be especially useful for borrowers who have never taken out a commercial real estate construction loan before.
Standard commercial construction loans will typically require borrower collateral to secure the deal. The benefit of providing security is that you will usually pay a lower interest rate than you may if the loan were unsecured.
As well as the options illustrated above, you may be able to fund your construction or renovation project with these alternative forms of business borrowing:
A CELOC (commercial equity line of credit) is a revolving line of credit secured by commercial property. It functions like a high-value credit card, enabling borrowers to access funds when they want as much as they want, up to the limit of the credit line.
Invoice financing lets you borrow against the value of your unpaid invoices. The lender usually provides up to 95% of the invoice value within a few days or even hours of the bill being raised. Your invoices act as security for the loan, no added collateral required.
If your construction or renovation project is modest, you may be able to cover the expense with a business credit card. These types of cards usually have higher credit limits than personal card accounts and may be available without providing collateral.
For a commercial real estate construction loan or any type of business loan, working with business finance experts can make all the difference when applying for funding. Contact Swoop to discuss your borrowing needs, get help with your application and to compare high-quality commercial construction loans and business loans from a choice of lenders. Don’t wait to start building your business real estate. Register with Swoop today.
Written by
Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Wells Fargo Bank, Visa, Experian, Ebay, Flywire, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of US consumer and business finance.
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