Commercial construction loans can be a source of revenue that many banks
count on to sustain growth. However, history has shown that taking on
these loans without proper risk management in place can also create losses
and add stress to a bank’s portfolio. The real estate market is
extremely cyclical, with peaks and declines that can be difficult to predict
accurately. Therefore, lending practices that adhere to certain guidelines
can help minimize losses for both lender and borrower. Lenders must mitigate
their potential for losses by monitoring the development project throughout
the entire process. This ensures milestones are met and funds are distributed
as needed to sustain construction through to completion.
Construction lending is not the same as lending on an existing property.
It takes a mortgage professional with experience in this niche market
to ensure risk is evaluated correctly and the lender’s money is
secure. It is the lender’s duty to monitor the conditions of the
markets where they are active in construction finance so they can apply
the best lending strategies for their borrowers.
Economic conditions do not impact all real estate sectors equally. The
demand for office space depends on the amount of office-related businesses
in a particular locale. The demand for retail space is affected by the
state of the economy and consumer spending habits. In the residential
sector, demand is influenced by the affordability of homeownership in
particular neighborhoods, interest rates, and stability of employment.
Lenders need to have a clear understanding of local markets and their
economic indicators to aid in determining the practicality of commercial
A commercial construction loan typically has had a bit of work done on
the project before a loan closing. The project developer must have already
concluded some items, including negotiating a parcel purchase, obtaining
title insurance, developing a project plan, consulting or hiring an engineering,
procurement, and construction firm (EPC), and obtaining the necessary
city or state permits for the project. The mortgage broker or lender will
then work with the borrower to negotiate a funding priorities list, draw-down
plan, and repayment schedule. The lender will also negotiate the terms
of the loan, and if they are acceptable, schedule a site visit and underwriting
overview of the entire project before proceeding to a loan approval and closing.
After the pre-qualification and underwriting guidelines are completed,
the lender and developer will work on final agreement items like project
insurance, the construction contract, and other post-closing requirements
not covered in the final closing. Once these items are completed and agreed
to by both parties, the lender is bound by the finance contract and must
fund the loan as long as the borrower meets all the requirements and terms
of the closing.
Once the loan funding begins, the lender is bound by the conditions of
the financing agreement. The lender is successful with their investment
only after the project is completed and the loan is repaid, either with
proceeds from the sale of the completed property or by refinancing the
project after it is occupied. While the project will have some asset value
to the creditor in a default, the value of the property significantly
increases once construction is complete and a certificate of occupancy
Commercial construction loans can be a lucrative addition to a lender’s
loan portfolio if they are conducted with the proper due diligence and
oversight. These types of loans offer lenders a better rate of return
than is typical of traditional mortgages, with the return of capital at
the completion of the project. The recapitalization allows the bank to
reinvest that money into another project, earning more fees in the process.
Although construction loans are specialized and take a bit more effort
in ensuring limited risk exposure, they can provide a substantial addition
to a lender’s annual revenue stream.
Contact Geraci Law Firm at (949) 298-8050 today, or contact
for more information.