A small business might need a commercial construction loan to fund a renovation or construct a new commercial building. Learn how these loans differ from traditional loans and the steps to apply.
Kymberlin earned her Bachelor of Arts in Creative Writing from Pacific University in 2020 and resides in Portland, Oregon.
WRITTEN & RESEARCHED BY Kymberlin Bush Kymberlin earned her Bachelor of Arts in Creative Writing from Pacific University in 2020 and resides in Portland, Oregon. Expert Contributor
Erica began writing on small business topics in 2008. She joined Merchant Maverick in 2018 and focuses on loans, accounting, and POS. She is a Certified ProAdvisor for QuickBooks Online and QuickBooks Payroll. She has been cited in MSN, Reader's Digest, Vox, U.S. News & World Report, and Real Simple. She is a graduate of Limestone University and resides in Greenville, South Carolina.
REVIEWED BY Erica Seppala Erica began writing on small business topics in 2008. She joined Merchant Maverick in 2018 and focuses on loans, accounting, and POS. She is a Certified ProAdvisor for QuickBooks Online and QuickBooks Payroll. She has been cited in MSN, Reader's Digest, Vox, U.S. News & World Report, and Real Simple. She is a graduate of Limestone University and resides in Greenville, South Carolina. Editor & Senior Staff Writer
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Whether it’s renovations or new construction, the time has come for your business to get a facelift. When it comes to funding your project, your small business might need a commercial loan to give you the resources to start.
Read on to learn more about commercial construction loans, when you should consider applying for one, what you can expect from the application process, and how they differ from commercial real estate loans.
Table of Contents
A commercial construction loan is used to finance the costs associated with the construction or renovation of a commercial building.
Funds from this kind of loan can be used to pay for labor or materials for the renovations of existing properties or for the purchase and development of land for a new commercial property.
Are you looking for a loan to purchase an already existing commercial property? You’ll need to look into a commercial real estate loan.
Commercial construction loans have several key differences from traditional loans. We’ll go over those below.
Commercial construction loans are not structured like traditional loans. Unlike loans you may be more familiar with, you will not receive the full loan amount as a lump sum and pay it off plus interest over time.
Commercial construction loan distribution differs from standard loans and includes the following unique aspects:
Other commercial construction loans like the Small Business Administration CDC/504 loan provide more long-term options, so an additional loan following the completion of the project will not be needed.
For commercial construction loans, borrowers should expect to pay interest rates between 5% and 18%.
The rate you end up with will depend, as always, on your credit score and lender. Traditional banks will typically offer the lowest interest rates while hard cash lenders tend to be higher.
Like any loan, you’re most likely going to encounter fees with a commercial construction loan. The fees below are not unique to these kinds of loan but are still important to keep in mind when you’re factoring the final cost of any loan.
You may encounter:
Learn more about common fees lenders may charge in addition to interest rates on a loan.
Because commercial construction loans are considered high-risk, most lenders are going to require a down payment.
A down payment takes some of the risk away from the lender and is typically between 10% and 30% of the total project cost.
It is rare for a lender to cover 100% of the cost of a construction project.
Typical lenders will use the loan-to-cost calculation for commercial construction loans. The equation for this ratio is the total amount of the loan requested divided by the total project cost. Here is an example:
A business requests a loan of $190,000 for a project that costs a total of $200,000
$190,000 / $200,000 = 0.95 and expressed a percentage the loan-to-cost ratio for this project would be 95%
Requirements vary by lender, but most will require a loan-to-cost ratio of 80% to 85%.
Following the example above, the lender would loan between $160,000 and $170,000.
What does a borrower do if a lender will only partially fund their project? The rest of the cost may need to come from their own pocket, but there are some other options, like mezzanine loans, which we’ll discuss later on.
Now that you know more about the commercial construction loan process, it’s time to explore the different types of loans available.
The Small Business Administration (SBA) CDC/504 loan is one of the most popular commercial construction loans.
Borrowers tend to choose these loans over others because of the low down payments, competitive interest rates, and credit score requirements in the high 600s.
With this loan, an SBA-approved Certified Development Company will fund 40% of the costs to renovate existing facilities, build new facilities, or purchase/improve land. Up to $5.5 million is available for borrowers.
Another lender will need to provide 50% of the project costs, while the borrower will be responsible for 10%. In some cases, borrowers may be required to pay 20%. Repayment terms are available for up to 20 years, and interest rates are based on the market rates that the U.S. Treasury issues.
The SBA also has the 7(a) program, which can be used for the purchase or construction of commercial real estate.
Through this program, borrowers can receive up to $5 million with repayment terms of up to 25 years. Interest rates are based on the prime rate plus a maximum of 2.75%. To qualify, borrowers should have a credit score in the high 600s and a down payment of 10% to 20%.
Here are the base rates and markups for a 7(a) loan from the SBA:
Thinking about applying for an SBA 7(a) loan? Check out SmartBiz, one of our favorite mediators of SBA loans:
A traditional commercial construction loan from a bank is another common option for business owners.
Rates, repayment terms, and down payment requirements vary. Generally, a minimum down payment of 10% is required, maximum repayment terms of 25 years are standard, and fixed and variable rates are available.
You can start your lender search by talking to your current financial institution about your financing needs. See our post on the best banks for small business loans if you’re interested in specific recommendations.
As we mentioned earlier when discussing loan-to-cost ratios, mezzanine loans are another option for borrowers looking for a commercial construction loan.
When a loan-to-cost ratio is lower than a borrower needs, and they have to find additional funds, a mezzanine loan might be an option. These types of loans are secured by stocks. If a borrower defaults, the lender can convert to an equity stake.
With a mezzanine loan, the borrower has more leverage and can achieve a loan-to-cost ratio of up to 95%.
You know about the types of loans available to you, so where do you find a lender? What steps do you need to take to apply? What does the application process include? We’ll go more into depth about applying for a commercial construction loan below.
Your application process is going to look different based on what kind of loan you end up applying for, but the first step is always going to be finding a lender.
Once you have a lender, you’ll begin the application process! This is when the lender will begin evaluating your personal and business financials, your credit score, and other factors that will determine whether you get approved for a loan and what your interest rates/terms will be.
Here are several things potential lenders will consider when you apply:
Your lender will also look at your industry experience and current business financials.
Commercial construction loans are considered high-risk, so you’re going to need to prepare yourself to provide documentation to prove that you’re a smart investment for a lender.
You’ll need to provide the following:
Remember, different lenders may require more or less than this what’s on this list.
Lenders are going to take a minimum of several weeks to go over your information because commercial construction loans are such a high-risk product. They may require more documentation or have other questions for you during this time, so check your email and answer phone calls while you’re waiting to hear about the decision.
Next, you will receive a decision from the lender. If you’ve been approved, it’s time to start the closing process.
Now it’s time to move into the closing process. This includes going over the loan agreement, which will have all dates and milestones you’re required to meet throughout the process in order to keep receiving your funds.
Once the paperwork is signed and the closing process is complete, you’ll be on your way to expanding your business.
Getting a commercial construction loan isn’t necessarily a quick and easy process. However, if you need to construct or renovate commercial real estate, it’s a great way to get the funding you need for even the biggest projects.
Whether you need funding for commercial construction or have other financial needs, make sure to get started with the best business loans for small businesses.
Kymberlin earned her Bachelor of Arts in Creative Writing from Pacific University in 2020 and resides in Portland, Oregon.
View Kymberlin Bush's professional experience on LinkedIn.
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