Business Construction Loans: What Owners Must Know Before Breaking Ground

The right first impression is critical to earning investor attention. Learn more about what lenders are looking for and how to craft compelling business construction loan applications.

Key takeaways:

• Commercial construction financing differs from other funding in key aspects.
• Lenders look for well-prepared proposals clearly outlining scope, budget, and timeframe.
• A full-service construction company can make loan applications easier.

Here’s a golden construction rule: financing comes before the foundation. And while properly sourced and vetted financing leads are critical, it’s becoming increasingly difficult to obtain commercial construction financing.

$1.8 trillion in commercial loans are ready to mature next year in a landscape where lenders are increasingly cautious about ROI. 

This can be challenging, particularly for small businesses seeking to finance a new commercial build or expansion.

That’s why, in this piece, we’ll explore why it’s essential to have a business construction loan before breaking ground. You’ll learn to understand how this funding works, how to qualify, and how to keep financing aligned with project scope.

You’ll also discover what lenders expect from a proposal, and how to avoid common financing pitfalls to keep your project on budget, and on schedule.

What Are Business Construction Loans?

Business construction loans are commonly used for projects like ground-up builds, expansions, or tenant improvements. They differ in some important ways from other funding, like real estate loans and standard business loans.

Construction loans are short-term in nature, typically ranging from six months to two years, with disbursements tied to project milestones. 

Other defining features of business construction loans include:

#1: Varying Interest Rates

Interest payments are usually higher than with other loans. Rates are based on the amount borrowed to finance each construction stage, so they’ll differ between projects. 

With some loans, interest on monthly payments is added for the life of the loan. With others, interest is only added during active construction.

#2: Large Downpayments

It’s a big risk for lenders to provide commercial construction financing, so the upfront payment from loan applicants must also be big. 

Down payments can be 10%, but expect to pay as much as 25%.

#3: They Don’t Cover Everything

Different lenders have their own rules about what you can and can’t do with your construction loan. Some only allow certain types of buildings. 

Others won’t cover things like builder’s risk insurance or closing costs, making it vital to know the loan’s limitations before signing.

#4: They’re Available in Various Forms

One of the most common is Construction-Only loans, which, as the name implies, only cover the construction phase and must be paid back in full when the project ends.

Small Business Association (SBA) 7(a) loans come from the federal government and can pay up to $5 million to cover a wide range of construction-related costs. This funding also has capped interest rates, which can make it more affordable.

Renovation loans also exist. They allow a business to modify or update a property it already owns, such as making energy-efficient alterations or expanding its size.

Those are a selection of available types, but every construction loan has something in common: lenders scrutinize applications to decide if projects are worth their investment.

The Loan Process: What Lenders Expect

A well-prepared proposal must comprehensively present your construction project as accurately as possible. 

The four essential topics to communicate when applying for business construction loans are:

• Your business plan and project scope
• Cost breakdown
• Contractor qualifications
• Project timeline

Lenders know construction costs can run over budget and that things can take longer than planned. They don’t need you to see the future; just to prove you’re prepared and experienced, and are providing an educated and confident estimate from clear, comprehensive data.

Common Pitfalls in Construction Loan Projects

Misestimating project cost is a typical pre-loan problem. Underbidding in hopes of securing funding is deliberate misestimation, and a sure way to lose funding mid-project as costs spiral and lenders cut ties.

Post-loan, projects can be badly impacted when contractors draw on commercial construction financing too early or too late, which makes responsible disbursement controls essential. Things can also collapse from inadequate insurance and lack of bonding, meaning all parties must be actively covered.

The amount of permitting and paperwork involved with business construction loans makes it easy for essential documents to be poorly completed or omitted. These all create gaps that can cause your application to be rejected.

Aligning Scope, Budget, and Financing

Applicants who clearly outline project goals and are upfront about the required funding will be the most attractive to investors. Underbidding to secure business construction loans isn’t recommended; this impairs cost predictability and can derail commercial construction financing mid-project when investors pull out.

Clearly defining your project’s scope from the outset also puts everyone on the same page and minimizes the need for change orders, which can add extra expense and time and displease lenders. 

Check out our guide to the essential elements of construction loan contracts for more on change orders and other important factors.

Keeping Your Project on Schedule and Budget

Maintaining a steady funding stream from business construction loans requires strategic planning. You can minimize the odds of any loan draw delays through one key word: communication.

All scheduled progress (and especially any new developments) must be made transparent at all times. Contractors must communicate clearly and consistently with each other and with all connected professionals, and this steady feedback should also extend to the loan lender.

Constantly relaying updates helps clarify timeline expectations and minimize the occurrence and impact of unplanned budgetary expenses. 

Working with a General Contractor like RPC, who understands lender requirements, will help your project communicate effectively with the right people.

A Solid Loan Builds a Solid Foundation

We can’t overstate the importance of well-prepared documentation and a clear project scope. Combined with an understanding of commercial construction financing, this will greatly increase the odds of securing business construction loans and getting your project off to a strong start.

RPC General Contractors can help align your build with your budget before you apply for financing by using our decades of experience in managing every aspect of business construction, from major priorities to the smallest details.

Get in touch with us today, and let’s get your construction project funded!