Construction loans: the guide for property owners

Three sources: three structures

Banks: lower leverage, lower pricing, often recourse. Best for sponsors with strong existing bank relationships, deposit balances, and 60% to 70% LTC requests.

Debt funds may consider construction structures that differ from bank programs. Review leverage, guarantees, reserves, draw conditions, fees and repayment obligations in the actual proposal.

HUD 221(d)(4): construction-to-perm with 40-year fully-amortizing rate-locked permanent take-out. 9 to 12 months to close. Best when long-term economics dominate and sponsor can absorb the HUD process.

HVCRE and the 15% equity test

HVCRE (High Volatility Commercial Real Estate) requires banks to hold 150% risk-weight against qualifying construction loans. Loans escape HVCRE if the borrower contributes 15%+ as-completed appraised value in cash equity that stays in the deal until conversion to permanent.

Draws and completion

Construction loans fund in monthly draws against approved budget categories, hard cost (per the GC's schedule of values), soft cost (architect, engineering, legal, financing), interest reserve, and contingency. Each draw requires lender's construction consultant inspection and certification.

Completion guarantees: standard on debt fund construction. Typically guarantees the lender will see the building completed per plans and specifications, even if costs exceed budget. Distinct from full repayment recourse.

Bonding: payment and performance bonds from the GC may be required by the lender. Adds 1% to 2% to construction cost. Common on larger deals; smaller deals often substitute sub default insurance or letters of credit.

Take-out planning

Most construction loans are pure construction with a separate permanent take-out arranged at stabilization. The construction loan typically runs 24 to 36 months with extension options for lease-up.

For multifamily takeout financing, compare applicable agency and other lender programs using projected completed-property income. Confirm eligibility and conditions before relying on a takeout amount.

Other CRE take-out: life co or CMBS for stabilized non-multifamily; bank perm for relationship-driven smaller deals. Take-out underwriting starts at lease-up milestones, not at construction completion.

Alternative: HUD 221(d)(4) construction-perm. Rate locks at construction start; permanent loan is the same loan, post-conversion. Eliminates take-out execution risk.

Process and timeline

Bank construction: 60 to 120 days from term sheet to closing depending on construction document review, environmental, and credit committee scheduling.

Debt fund construction: 60 to 90 days. Faster credit decisioning offsets the more involved closing checklist for construction administration.

HUD 221(d)(4): 9 to 12 months from MAP lender engagement to closing. The HUD review is exhaustive; the trade-off is the 40-year fully-amortizing rate-locked perm.

Sizing math

Loan-to-cost (LTC): max loan / total project cost (acquisition + hard cost + soft cost + interest carry + contingency). Bank typically 60% to 70%; debt fund typically 70% to 80%; HUD up to 87% loan-to-replacement-cost.

Loan-to-stabilized-value: max loan / lender's projected stabilized value. Typically 65% to 75%, and both LTC and LTSV must be satisfied.

Stabilized DSCR: max loan whose annual debt service equals projected stabilized NOI / required DSCR. The take-out underwriting typically applies; if the projected stabilized DSCR can't support the construction loan balance at projected take-out rates, the construction loan is too big.

Frequently asked questions