Construction Loans-Part 2

July 1. 2023

Unlike my previous Newsletter about construction loans, this edition is rather short and to the point. We have already discussed the preliminary steps to obtaining the construction loan. Now I would like to delve into the lending options available. Previously we went over some of the limitations regarding banks and their policies. There is no doubt that you will get a better interest rate with bank financing. The limitations include lower loan-to-values (LTV's), lower loan-to-costs (LTC's), limited lending area and the time it takes to close. Closing a bank loan can take up to 90+ days. Closing a private money loan can take up to 60 days to close. Let's explore and compare bank loans to private loans.

There are many different construction lending options. What the developer or the rehabber need to ask themselves are these key questions:

• When do I absolutely need to close? If it takes up to 90 days to close, will my permits expire before I can get funding? Very important to keep in mind is even though approved permits are good for two years from date of issuance, if work stops and starts in a period of six months or doesn't proceed for six months, the permits will expire!

• What is my tolerance for interest rates? Interest rates are subjective to many things, but as stated earlier, the banks (especially your local banks within the city of your construction project) will have lower interest rates than the private lenders.

A little more on how interest rates work: As you know, you can be quoted a 7% interest rate, a 9% interest rate, even a 15% interest rate. But what are these rates contingent on? The interest rates are dependent on more than what the private lender's or bank's starting quote is. Your quoted rate will also depend on your experience as a developer or rehabber, the property's location to an MSA, the probability that the project will be profitable whether you rent or sell the units, your liquidity and your net worth. As a side note, I highly suggest that when you are shopping for rates that you DO NOT ask for a SOFT QUOTE! Once all of the requested documentation is in, that's when you get the actual interest rate. So, the moral of the story is, don't ask for fluff when you can get substance! Also, keep in mind that construction loan interest rates are normally an interest-only product meaning nothing toward the principle. This is ideal since the loan will be a bridge loan until the completion of the project. Construction bridge loans can go as long as 36 months and can sometimes be extended beyond that. Some private money lenders have an option for an "interest hold-back." Meaning, for six months (possibly more) the sponsor doesn't pay anything on the loan due to the fact that a certain amount of the construction loan proceeds are withheld. One more thing, interest rates are also contingent on the required Geotech Report. The results of this report will also give the lender confidence in your project - or the lack there of. Here's what's included in a Geotech Report:

• Identification of the type of soil

• The strength and density of the soil

• Any organic material or contamination present

• Ground water and soil compaction

• Foundation design recommendations

• Seismic design factors

• Solutions for any foreseeable problems

For more information: https://designeverest.com/research-library/geotechnical-reports-what-it-entails-on-your-property-and-the-cost-of-getting-your-soil-tested/

• Do I have the required net worth that a bank or private lender will require? Most banks like to see 50% net worth in accordance with the construction project. In other words, if your construction project will be at a cost of $50MM, then obviously you need a net worth of $25MM. As with private lenders, (always being more flexible than banks) net worth can be between 25% and 10% in accordance with the cost of the construction project.

• Do I have at least 20% down for the construction loan? Remember, even though private lenders are more flexible than banks, there is no getting around this.

• Do I have the required liquidity? This is different than net worth in that it is the required "reserves" such as cash on hand which includes checking, savings, 401K's, stocks, bonds, etc. Whatever is readily liquid. I recommend no less than 20% liquidity. Having 20% liquidity (which is in addition to your 20% downpayment) makes you a strong borrower and gives you the latitude to pay for whatever comes up. Murphy's law! However, 10% liquidity is usually acceptable with private lenders.

Now that we have analyzed what lenders both, banks and private will require for construction funding, the choice is yours. You must decide how soon you need to close the loan, how much liquidity and net worth you have and your tolerance for interest rates and the terms of the loan.

This edition was supposed to be shorter! However, I strive to be thorough in communicating the information. As always, reach out to me with any questions or clarification: cjones4loans@gmail.com

Until next time, be safe and be well!