4 Types of Construction Lenders For Your New Development Project

At this point in the life cycle in your new apartment development project, you need to select the type of construction lender appropriate to your situation, get ready to close our construction loan and begin building your apartment units. In this article, we will describe the general types of construction lenders. In future articles, we will go on to delineate the process for finding and identifying lenders, and a general description of the underwriting process to secure a construction loan.

First, the general types of construction lenders (finding lenders and underwriting will be included in future posts):

1. Commercial Banks - your most standard plain vanilla type of lender, usually with the lowest interest rate and loan costs. The trade you make for this lower costs are:

A. rigorous, sometimes invasive, underwriting of the principals and managers of the development team, and the real estate deal itself.

B. requirement for full recourse guarantees, including full completion and repayment guarantees.

C. more conservative loan terms related to Loan To Value (LTV) and Loan To Cost (LTC). As well, many construction lenders will be more conservative in their underwriting of the permanent loan amount, as this is one of the main sources of repayment of the construction debt. The bank looks at it this way, in the instance that they will need to foreclose the construction loan, they will be more careful to make sure the deal can be viable under a foreclosure scenario.

D. more conservative stance on being "in the market" or not. Commercial lenders being subject to banking regulators, will be in and out of the lending markets much more often than the other lenders below.

2. Hard Money Lenders - a much more aggressive style of lender, both in terms of the deals and developers they will fund, and also in terms of cost (much higher rate and points), and speed of loan close. You might see loans rates anywhere from 7% to 16% per annum, normally structured as interest only, and loan fees anywhere to 2 to 10 points.

Advantages:

A. These folks lend when commercial banks may not. They want to get there money working, and unless the markets is totally off, you can generally know that some hard money lender somewhere is lending, at a cost.

B. Less rigorous underwriting of principals, sometimes no underwriting. They will focus in that case, on the real estate solely.

C. Speed of execution and closing. Sometimes, these folks are RE developers themselves, and can make fast decisions on a loan, generally without a loan committee as you would have with a commercial bank. Loan documents tend to be simpler and faster to be produced. Many do not require or don't need an appraisal. These all save time and get you to a close quicker on your deal.

Be very careful, to vet lenders in this domain, there are for sure some scam artists. Some of these folks, operate in the "loan to own" domain, meaning they would be just as happy to see the developer default, so they can take the deal over to own it themselves. As a new developer, you'll be inclined to talk to anybody who even looks your way to start a conversation about lending on your project, but you must check references, see other deals they've done, and talk to other developers who have used their loan products. There are honest and forthright hard money lenders out there, you just need to turn over more rocks to find the good ones.

Finally, by all means, do NOT pay upfront fees for them to underwrite your deal before issuing a term sheet. It sounds crazy and silly, but believe me, it happens more than you think. An honest lender will do some upfront work and underwriting, to get to a point of at least issuing basic terms in writing; a crooked lender will ask for money upfront to even begin looking at your deal. Look the lender up on a Google search, if they are hard to find, or you can't find info on the principals, or they seem to be under multiple company name, or associated with fishy circumstances - run, the opposite direction, fast. If it's too good to be true, it probably is.

3. Crowdfunded Lenders - this is a new evolution in lending. These crowdfunded lenders raise capital under the crowdfunding regulations promulgated under the JOBS Act of 2012 and associated SEC regulations, and then loan it to your project. Our experience is they sit somewhere in between commercial bank loans and true hard money, in terms of rates and points. It's worth looking at, and what's more, we have found because of the public scrutiny of being in the public domain, there seems more transparency and ability to research these folks. Still, always check references and do your homework.

4. All equity - this sounds odd, but one way to get a loan, is to raise all equity. If you can do it this way, it generally is faster, less pain-in-the-*** underwriting, but higher cost in terms of ownership and profit splits you give away on the deal. And overall your return on equity and IRR will be lower. For the right deal this can work.

This list is by no means exhaustive, and I encourage you all to talk about other types of lenders out there, please add them in the comments to this article. Looking forward to hearing more!

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Scott Choppin is the Founder and CEO of the Urban Pacific Group of Companies, which focuses on urban infill real estate development and real estate development advisory and projects services to family offices, landowners, and commercial businesses.

Urban Pacific was founded in 2000, and focuses on the development of multi-family rental projects throughout California and the Western United States. Urban Pacific has developed real estate projects with a total historic deal valuation of over $900M.

Urban Pacific Realty Advisors, a wholly-owned subsidiary of the Urban Pacific Group of Cos, provides real estate development advisory and project services to family offices, landowners, and commercial businesses. A recent and ongoing client is the San Pedro Fish Market, the 11th largest restaurant in the United State, where Urban Pacific was hired to facilitate multiple real estate development and construction management projects on behalf of SPFM.

Urban Pacific is based in Long Beach, CA