Construction Loans: Overcoming the Two Special Risks that Make them Challenging
Construction projects of all sizes require special financing to ensure funds are available to cover the costs at every stage. However, there are two factors which could present major obstacles with construction loans. The first is that collateral value is only achieved upon project completion. The second is cost overruns in the budget. Both risks can cause a construction project to grind to a halt, but there are ways to overcome these special risks to get the necessary financing.
Construction Risk and the Completion Guaranty
When seeking a construction loan, there is an understood rule that the property used to secure the loan will not achieve its true value until construction is complete and the project is generating revenue. For lenders, this presents a big risk because construction may not see completion, leaving the lender to take over the project. One way to reduce risk and ensure approval for a construction loan is to submit a third party construction guaranty. A third part construction guaranty reduces risk by ensuring a construction project will reach completion on schedule, with the approved plans, free of liens, within the approved budget, and in-line with any additional provisions in the plans. The third party guaranty may include carry costs, such as taxes, insurance, and utilities, based of the theory that such expenses are incurred over the course of the construction project. Third party guaranties ca be very detailed to cover contingencies, but they reduce risk to the lender, and help ensure that adequate funding is provided at every stage of the construction project.
Construction Risk and Budgetary Overruns
Lenders are also wary of the financial risks involved with construction projects. Many people underestimate costs and do not thoroughly plan projects. This is often seen when construction companies are bidding on projects. It is not unusual to see multiple change orders throughout the course of a project, which can cause tremendous budgetary overruns, and lead to funding requirements that exceed the amount offered by a construction loan. When seeking a construction loan, provide the names of the contracting companies working on the project, as well as a plan of attack with the estimated cost of materials, labor, and allowances to unexpected costs. Include a project plan, detailed with time frames for each stage. Everyone who has been involved in construction projects has heard the horror stories of a seemingly reasonable contract with turned out to either blow the budget, or a project which was only partially completed due to incompetence. Lenders have also heard these stories. Having a detailed plan of attack, reputable contractors, and a thorough budget all help to greatly reduce the risk of budgetary overruns.
CounselPro Lending specializes in commercial real estate financing solutions for projects of all sizes. Whether you are renovating or expanding an existing structure, or if you are taking on a large construction project from the ground-up, we will provide financing tailored to your needs, so you can complete our project on time and within your budget. Contact our offices today to get started.