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The real estate market is ever-evolving, and there has been a growing trend toward ground-up construction. With existing home inventory remaining at historic lows and no improvement in sight, new construction will be one of the solutions to the current housing crisis—and savvy investors will reap the rewards, with an average of 10% to 20% gross profit on projects done right.
For builders, a successful project is one completed on time and within budget. But that is no easy feat these days. According to the Construction Management Association of America, 98% of construction projects go over budget. To put it another way, that’s 9 out of 10 projects, according to the International Journal of Innovation, Management and Technology.
So what do you do when your construction project doesn’t go according to plan? Let’s dive into your financing options that can help get you back on track and over that finish line.
What Are Construction Loans?
Construction loans are short-term, interest-only loans that fund the building of a home. Whether it’s a tear-down or ground-up project, many lenders offer short-term construction loans, often at a high rate due to the increased risk.
To ensure the project progresses, most lenders will require you to finance the construction budget within the loan, and as work is completed, you submit request for “draws” to reimburse you. Since these loans tend to have shorter terms, typically for a period of 12 to 18 months, developers have very little wiggle room for unexpected issues or delays during the building process.
There are a multitude of elements outside a developer’s control—specifically labor shortages and increased material costs. The construction industry is still facing a lot of problems in these areas as a direct result of the pandemic. According to a 2022 survey by the Associated General Contractors of America, over 90% of construction firms are finding it difficult to find qualified professionals. And while construction prices are not surging at the breakneck speed they did during the pandemic, the industry is still seeing construction input price rises of 4.9% year over year as of January.
Time and costs are the two essential components of every ground-up construction project that are always interrelated. If your project starts experiencing delays or budget overruns, it can quickly turn into a nightmare of missed deadlines, quality compromises, and financial strain. The right financing solution can make all the difference in getting your construction over the finish line without sacrificing quality and/or profits.
If your loan is reaching maturity and/or you’re going over budget, here are a couple of different routes developers take:
1. Rush to complete the project on time and compromise on quality—an undesirable option in every way.
2. Try to get an extension on the terms, which comes with paying expensive extension fees or, even worse, no option from the lender to extend at all.
3. Refinance to pay off the loan, extend loan terms, and get more funds to complete the project.
The Lender Extension Trap
You may be thinking: “Can’t I just extend the loan if it runs over the timeline?” That used to be an option, but not so much these days because the landscape of construction lending has shifted significantly over the past year.
Until March 2023, the largest share of construction loans belonged to regional and local banks, at 31% of all loans. Overall, banks of all sizes accounted for 60% of all construction loans.
This healthy lending activity was disrupted when a number of regional banks began failing in the second quarter of 2023, leading to a liquidity crunch and subsequent retreat of regional banks from the construction lending sector. Those that do still operate in this space have tightened their rules, and most no longer offer construction loan extensions. Those that do charge hefty fees.
For a builder or developer operating within already tight margins, these fees can throw the entire project into jeopardy. For example, a mere 1% extension fee on a $3 million construction loan would cost you $30,000 out of pocket.
A Construction Completion Loan: The Superior Solution
Given the limited availability and additional expense of extensions, what recourse do you have if your construction project is going over time and/or budget? Consider a construction completion loan.
A construction completion loan is, in essence, a rate-and-term refinance based on the higher appraised value and can include a construction credit line for builders who need more funds. In addition to that, any loan costs associated with the refinance can be rolled into your new loan, so you’re not paying any costs out of pocket, helping your overall liquidity.
This provides developers/builders with three valuable outcomes:
1. The ability to pay off a maturing construction loan.
2. More time to complete construction and sell the property without sacrificing quality.
3. The ability to use the funds from a construction credit line to see the remainder of the project through.
Who Is Eligible for a Completion Loan?
When structuring out financing mid-construction, lenders need to determine borrower qualifications and project viability. You must have a good credit rating, a satisfactory level of experience in new builds, and a property at the mid-construction stage.
Lenders that offer construction completion loans will consider projects that are roughly 75% complete and satisfy three main criteria:
1. The property is weathertight; the foundation, frame, roof, doors, and windows have been installed; the siding is complete.
2. The property has rough plumbing, rough electrical, and HVAC.
3. There are no mechanic’s liens on the property. A title report will be pulled to ensure there are no mechanic’s liens on the property. Lenders want to make sure you are paying your contractors and subcontractors.
Let’s consider a real-life example. A builder in Atlanta took out a loan for $3.1 million on a luxury single-family construction project with their local bank. When the builder realized the project was going over budget and would not be completed on time to pay off their maturing loan, they worked with a hard money lender for a mid-construction refinance.
The lender agreed to a 12-month refinancing loan at 90% LTC (loan-to-cost). The new total loan amount came out to $3.9 million (not including closing costs). Included in their new loan amount was an additional $800,000 in construction financing since the property value increased and the builder had a much more accurate budget to get it completed.
With their new loan, the builder was able to pay off the maturing loan with their original lender and use the additional $800,000 in construction financing to get the project over the finish line without sacrificing time and quality.
Finding the Right Lender for Construction Completion Financing
Are you in the final stages of a construction project, but a loan maturity is threatening to derail your project? Do you need to more time to complete your project, but don’t have room in your budget for pricey extension fees? Has your project gone over budget, but there’s still work that needs to be done?
It’s important to do your research, as not all lenders offer construction completion financing. Your goal is to find a lender experienced in construction completion loans because they understand the complexities of these types of projects.
This financing solution is a great tool for builders who are approaching the finish line on one of their builds—giving them more time and capital to complete their projects and collect their profit instead of being dragged down by cost overruns or fees from their maturing loan.
Remember: Successfully negotiating a construction completion loan is about building a relationship with a lender—or your capital partner. At CV3 Financial, we understand your needs, whether you are building a rental, flipping a home, or looking to consolidate your portfolio into a single loan. CV3’s Construction Completion Financing is here to help you get your project across the finish line!
This article is presented by CV3 Financial
CV3 Financial Services was built by and for real estate investors to provide both purchase and refinancing options for investment properties in 30+ states. CV3 delivers direct answers, quick closings, and flexible solutions for bridge, fix and flip and rehab loans, as well as adjustable or fixed rate rental property financing. With their diversified financial strength, CV3 is a lender that delivers speed, leverage, and consistency.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
