Owner-Occupied CRE Construction Financing 101!

An Owner-Occupied CRE Construction Loan is just an Owner-Occupied CRE Permanent Loan with a construction bridge loan component added! You underwrite a construction loan the same way you would a permanent loan…with a few additional steps! If a prospect, existing client, or referral source asks you about CRE construction financing, you have to be ready to convince them that you can get the job done! A construction loan is a bit more involved than a permanent loan, but it is surely not rocket science! Even if you have not been involved in a construction loan before, the information below is enough to convince your prospect, client or referral source that you can get the job done!

Step 1: Key Questions To Ask Your Borrower

You credit team is going to have a lot of questions about your construction deal. If you get answers to the questions below, you will likely be able to answer all the initial questions they have about the opportunity. You credit team will be able to guide you as far as next steps are concerned.

1. Do you have previous ground-up construction experience?
2. Have you selected a general contractor?
3. Have you purchased the land? If no, are you in escrow?
4. Any entitlement issues?
5. Do you have construction plans, permits & budget?
6. What is the estimated construction start date?
7. What is the estimated construction completion date?
8. Does the market support the property being built (value, rents, etc.)?

Step 2: Collect The Required Documents

In addition to asking the key questions above, you also want to start putting together a loan application package. You want to collect the same documents you would request for a traditional owner-occupied commercial real estate loan. Below are the construction-related documents your credit team will likely request.

1. Request the same documents you would for a permanent loan
2. Construction Plan
3. Construction Permit
4. Construction Budget
5. Contractor Information and Financials
6. Existing Appraisal or Environmental Reports

Step 3: Underwriting Considerations

If you don’t underwrite your own deals, below are some of the construction-related underwriting steps your team will be taking to get the construction loan approved. You can use this information to answer any questions your prospect, client or referral source may have about the construction loan approval process.

1. Approve a Permanent Loan (Take-out Loan) & Bridge Loan (Construction Loan): your credit team will underwrite the construction loan the way they underwrite a permanent loan. The difference is that they will also approve a Bridge Loan. The borrower will draw on the bridge loan during construction. After construction is complete, the Permanent Loan (whether conventional or SBA) will pay off the Bridge Loan.
2. Perm Loan Options: can either be Conventional CRE, SBA 504 or 7(a)
3. Bridge Loan: is typically an interest-only 12 to 18 month loan
4. Engage your CDC: if you will be using a SBA 504 structure for the permanent loan
5. Construction & Interest Reserve: your bank will require a construction and interest reserve. The interest reserve will be used to pay the interest on the bridge loan during construction. The construction reserve is in addition to the interest reserve based on the risk profile of the borrower and the construction phase LTV requirements your bank may have. Your credit team will let you know exactly what the reserve requirements are for your bank.
6. LTV Requirement During Construction: your bank may require a lower LTV during construction than it does for permanent financing. For example: if you are using a SBA 504 structure for the permanent loan (which is 90% financing), your bank may require 80% LTV during construction.
7. As-is As-completed Appraisal: your bank will underwrite the loan to the projected appraised value of the property. An appraiser will use the construction plans and budget to estimate the value of the property as completed.
8. Environmental Report: your bank will require at least a phase 1 environmental report.

Step 4: Construction Phase

The construction project goes on auto-pilot during the construction phase. Your credit team and the construction department handle iinspections and disbursements.

1. Construction Monitoring: your credit team will either require your construction department or a third party to monitor the construction project. The cost of the monitoring is an additional cost that the borrower is required to pay.
2. Bridge Loan Draws: the general contractor will request payment based on predetermined percentage of work completed. The construction monitoring team will inspect the work to ensure that it has been satisfactorily completed and pay the contractor. Each contractor payment will result in a draw against the Bridge Loan.

Step 5: Construction Completion

Once the construction project is completed, your credit team and construction department once again jump to action. You will have to get your borrower to sign permanent loan docs.

1. Certificate of Occupancy: The construction department or third party verifies that all contractor liens have been removed and that the certificate of occupancy has been issued.
2. Permanent Loan Docs: your borrower will have to sign loan documents for the permanent loan.
3. Bridge Loan Payoff: the bridge loan is paid off with proceeds from the permanent loan.

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