Construction loan at 9.75% or pay cash?

Question

Hello! I have purchased one of Rent to Retirement’s new builds in Cape Coral Florida. It is estimated to take about a year at 9.75%. Is it better to take out the construction loan or pay cash?

Zach Lemaster · Answer

@Chris Harper

Extremely useful insight you provided from someone doing multiple builds in the area!  I agree with everything you said!

@Michelle Moe

I am more than happy to discuss any questions you have on this, and specifically run through some scenarios with you if you'd like.  Just let me know.  Very much a personal decision, but there are benefits to involving a lender as Chris very nicely outlined.  For me, I like to always look at the best & most optimal use of my capital.  While we could pay cash for our own builds, we decided to leverage them to ultimately do more builds providing an overall greater ROI & equity position across multiple doors using financing instead of cash.  Interest is only paid on funds drawn at each draw which reduces the amount of interest paid during the build.  While the interest rate is higher for construction loans, you would not be paying that amount on the full amount of the loan.  Interest is applied on the amount of capital taken out on draws to date each month.  Annualized the interest rate is probably less than 5% considering how the draw process works.  I would plan for a total build time of 16-18 months if you are including permitting in that timeline even though there are no draws during that period.  Feel free to reach out with any specific questions!

Chris Harper · Answer

Hi Michelle,

Congratulations on your investment! I'm a little late to the thread but having gone through the process of building homes in Cape Coral the last few years I would say there are a few things to consider. While you will certainly reduce the holding costs and fees associated with the project out there are some pros to working with a lender (in my limited experience):

- The lender's operations teams will manage the draw schedules and due diligence. They are protecting their capital in many deals so in theory they should have good processes and connections to manage this. For example on each draw schedule they will send an inspector out to the property and do an inspection/report to the lender before giving more money to the builder. I could send you some samples if interested from my properties. I'm sure you could self manage this and hire a company but I like having that responsibility covered at least in the learning phase.

- In the construction contracts that I've seen they defer to financing terms. The terms obviously cover the lender's best interests first but generally are aligned with investors areas of risks.

- Lender due diligence on the builder can help protect you. Is insurance in place, are lien release documents done, etc.

Of course there are negative to working with a construction lender I'm sure you will be much more responsive and avoid delays but as a new investor it might be something to consider.  I've thought about using private financing for construction with better terms or maybe some of my own capital to do similar types of deals as the one you are mentioning. I doubt that construction lending is causing any of the delays in the Cape. Personally I think I'd be hesitant to manage that part of the financing myself. At least while learning the ropes, although if it's your own money and your comfortable with that approach I'm sure it can work. RTR can probably help you manage this approach too (likely have a few investors doing the same thing).

Good luck!

Robin Simon · Answer

Almost always depends on your personal financial situation - most importantly, what would you be doing with the cash for the next year that you hold on to if you don't take on the debt?

Michelle Moe · Answer

Thanks to everyone for your input! I decided to pay cash,

Sergey A. Petrov · Answer

Will your cash generate a 9.75% return elsewhere? If yes, finance it (interest should be tax deductible too). If no, pay cash. Whatever return your cash generates may or may not be subject to taxes depending on how and where it is invested as well so that is another piece of the puzzle

Ricardo Hidalgo · Answer

9.75% seems high for construction loan. I would explore other options or lender . I know I got quoted 6% interest only by draw amount plus 1% origination fee for my construction loan.

Michelle Moe · Answer

Hi Robin, thanks for your reply! I have about 350,000 in liquid cash, and I owe 220,000 on the house… so I’d put aside 280,000 ish for that. At the moment my investments have dropped well below the 9.75% for the loan. The plan at the moment is to sell upon completion, depending on the equity. I would like to invest in more real estate, but holding out for a bit. Since the build is in Florida and I’m in Ca., is there an advantage to having a lender for each stage of the draws?

Construction loan at 9.75% or pay cash?

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