Commercial Construction Financing: How Do Construction Loans Work?

Commercial construction comes with significant financial demands that may only be manageable with loans. Understanding how these loans work and their application requirements ensures you secure the financing you need at the best rates, ultimately setting your project up for success.

Key takeaways:

• Commercial construction loans are significant sources of financing for large-scale commercial projects.
• Construction loans are not the same as mortgages; these loans provide funds in stages as construction milestones are achieved.
• Several construction loan types include SBA 7(a) and CDC/504 loans.
• SBA 7(a) loans provide up to $5 million with flexible terms and affordable interest rates.
• CDC/504 loans offer long-term, fixed-rate financing for businesses aiming to purchase or improve their facilities, with stricter eligibility requirements.
• Preparing a detailed construction plan, maintaining a strong credit score, and having a solid business plan are essential to securing a commercial construction loan.
• Partnering with a reputable General Contractor increases your chances of securing a construction loan while assuring you of the successful completion of your project.
• Pre-approval for a construction loan helps clarify borrowing terms and strengthens your negotiating position with contractors and suppliers.

Commercial construction projects, such as restaurants, retail spaces, or historical renovations, come with substantial costs. 

According to a 2023 Construction Outlook Survey by the Associated General Contractors of America, rising construction costs are one of the top concerns for over 70% of contractors. 

For independent business owners and large corporations, pooling funds for these projects may take too long, and sometimes, the vision may never become reality. That’s where commercial construction loans come into play, providing the capital necessary to turn plans into tangible, successful ventures. 

These loans bridge the gap between your vision and its execution, ensuring your project has the financial backing to move forward without unnecessary delays. 

But first, how do these loans work? Here’s everything you need to know about commercial construction financing. 

What Is a Construction Loan?

Unlike mortgages, which are primarily used for purchasing property, commercial construction loans are specifically designed to cover the costs of building or renovating commercial properties. 

These loans typically have higher interest rates and shorter terms than mortgages, reflecting the increased risk and complexity of construction projects.

Once you qualify for a construction loan, you receive the amount in stages, meaning the funds are only released as needed. This method of disbursement is known as a draw schedule, where the lender provides funds as you reach specific milestones, such as the completion of the foundation, framing, or roofing. 

This structure protects the borrower and lender, ensuring that your contractors observe the completion timeline and stay within budget. 

For instance, suppose you’re looking to build a new restaurant. A construction loan can help afford to purchase land and construction materials, hire contractors, get a license, and cover other critical expenses.

Types of Construction Loans

You can access various types of construction loans, each with unique advantages and disadvantages. 

The two most common types are the SBA 7(a) and CDC/504 loans.

The SBA 7(a) Loan

The SBA 7(a) loan is a common option for individuals seeking commercial real estate construction financing thanks to its flexible terms. 

The loan offers a cap of up to $5 million with a payment term of up to 25 years. The financing option features an affordable interest rate, the prime rate, and an additional 2.75%.

Depending on the loan amount, borrowers must make a downpayment of between 10% and 20%. In addition to the downpayment, lenders consider your credit score to establish your eligibility and the amount you qualify for.

The CDC/504 Loan

The CDC/504 loan is another option for financing commercial construction projects, particularly for businesses looking to purchase or improve their facilities. This loan promotes economic development and job creation by providing long-term, fixed-rate financing for significant fixed assets.

The CDC/504 loan is structured differently than the SBA 7(a) loan. It consists of three parts—a first mortgage from a private lender covering 50% of the project cost, a second mortgage from a Certified Development Company (CDC) covering up to 40%, and a down payment of at least 10% from the borrower. 

The loan is applicable for purchasing land, constructing buildings, and buying long-term machinery or equipment.

The main advantage of the CDC/504 loan is its low fixed interest rate, which can provide significant savings over the loan’s life. However, the application process is more complex, and the eligibility requirements are stricter.

How Can You Apply for a Commercial Construction Loan?

Applying for a commercial construction loan involves several steps, each critical to securing the necessary funding for your project. 

Here’s what you need to know.

1. Prepare a Detailed Construction Plan.

Your commercial construction plan is the foundation of your loan application. It should include detailed architectural drawings, a timeline, and a breakdown of costs. 

Lenders will use this plan to evaluate your project’s feasibility and establish how much funding you need. A well-prepared construction plan shows your commitment to the project and helps build trust with the lender.

2. Have a Strong Credit Score.

A good credit score increases your chances of qualifying for a high loan at the best rates. 

Lenders want to ensure you have a history of managing debt responsibly and are likely to repay the loan on time.

3. Provide a Down Payment.

Most commercial construction loans require a down payment, starting from 10% of the total project cost. 

This down payment shows the lender your commitment to completing the project and paying off the loan. The higher the downpayment, the higher the chances of qualifying for a larger loan with more favorable terms. 

4. Present a Solid Business Plan.

Lenders will require a comprehensive business plan in addition to your construction plan. 

This document should outline your business goals, market analysis, and financial projections. A strong business plan demonstrates that your project is feasible and likely to succeed financially.

5. Secure Pre-Approval

Pre-approval clearly outlines how much and on which terms you can borrow. It also strengthens your negotiating position with contractors and suppliers, as they’ll know you have the necessary funds secured.

6. Work With a Trusted General Contractor.

Partnering with an experienced and reputable General Contractor can significantly improve your chances of securing a construction loan. 

Lenders prefer working with contractors with a record of meeting deadlines. 

Secure a Favorable Construction Loan With Help From RPC General Contractors

Commercial construction loans provide the means necessary to turn your vision into reality. By understanding the different types of loans available and how to properly apply, you can secure the necessary funding to ensure your project’s success.

Remember to prepare a detailed construction plan, maintain a strong credit score, and partner with a trusted General Contractor, like RPC General Contractors.

If you’re ready to start your commercial construction project, contact RPC General Contractors today for a free estimate and expert guidance on securing the best financing.