Have you ever driven by a new commercial construction and wondered how the developer came up with the money to complete the project? Needless to say, commercial building projects are complicated. So is the funding process, and a typical project is funded in four stages. However, some projects require a few more.
Financing a commercial building project is not as simple as going to a single bank and obtaining the entire amount. Most projects require multiple sources of funding. And even if a single source is willing to cover the entire cost of a project, funding is released gradually. Certain requirements have to be met before each round is paid out.
Stage 1– Land Acquisition
The first stage of funding is designed to facilitate land acquisition. The developer finds a piece of land and does the necessary work to ensure it is suitable for the desired project. Once that is done, it is time to obtain financing to acquire the land. More often than not, this means going to a hard money lender or private ‘land bank’ that specializes in land acquisition deals.
Banks tend to shy away from land acquisition, at least according to Salt Lake City’s Actium Partners. Land acquisition is too risky for commercial banks. It is less risky for hard money lenders with a bit more flexibility in how they lend.
Stage 2 – Horizontal Improvements
Once land has been acquired, it needs certain horizontal improvements before construction begins. Simply put, developers need to build the necessary infrastructure. They need to construct roads and retention ponds. They need to run electricity and sewer. They may need to take down trees or set up barriers to protect adjacent properties.
Banks tend to be hesitant to fund these sorts of improvements as well. Again, it is too risky until a piece of land actually has building on it. So developers typically turn to hard money lenders for horizontal improvement loans.
Stage 3 – Vertical improvements
The next phase of commercial construction funding involves vertical improvements. In lay terms, this is the actual construction of the buildings themselves. This is when banks are a lot more willing to get involved. They can more readily loan on projects that will create buildings they can repossess and sell if necessary.
Interestingly enough, some hard money lenders willing to fund land acquisition and horizontal improvements won’t touch construction loans. They see construction loans as either too risky or not capable of returning a sufficient ROI. So they fund the first two stages and then leave the rest of the project to banks.
Stage 4 – Stabilization Funding
Last but not least is stabilization funding. This is funding meant to stabilize a project’s finances in advance of applying for the permanent financing that will pay off all the previous loans. Stabilization funding is not necessary for every project, but it is a tremendous help on projects that will not generate sufficient revenue right away.
Commercial office space is a good example. It could take some time to realize 100% tenancy. In the meantime, the developer might need a stabilization loan to keep the building operable. The loan will carry the developer through until all units have been rented and they can apply for permanent financing.
It wouldn’t be surprising to learn that land developers wish funding their projects were easier. But it is what it is. Financing commercial construction projects is complicated because the projects themselves are complicated. Most projects require multiple lenders including hard money firms and traditional banks. In the end, it all comes together when a project is completed, permanently financed, and generating revenue.
