A construction loan is a short-term loan used to finance the building and tenanting of your development project. Getting a construction loan for multifamily real estate is a key step in development, and one of the most difficult, as it represents a huge commitment from a lender and can entail a lot of risk. Your success is highly dependent on your presentation, which should include solid documentation to support your application and your additional financing, as you will receive funding for far less than the total project cost.
What You Get with a Construction Loan for Multifamily Real Estate
Construction lending has traditionally been the domain of local and regional banks, and that remains true today, with small banks making most multifamily housing loans under $30 million. Large banks are becoming more active in this area, however, thanks to a growing market and relaxation of Dodd-Frank regulations introduced after the 2008 recession. In addition to banks, insurance companies and private equity funds also originate construction loans.
After completion of construction and reaching occupancy at the average market level, the project’s level of risk decreases sharply and the construction loan is replaced with long-term (so-called “permanent”) financing. In recent years, the line of construction loan products has expanded to include construction-to-permanent and combined construction and “mini-perm” loans. It is also common to finance acquisition and development of the land as part of your construction loan.
Multifamily real estate construction loans are funded in disbursements. An initial payment is made to cover expenses that have already accrued; after that, payments are made on a regular basis. The borrower does not pay interest on the funds before they are disbursed.
Conditions may differ drastically among lenders, especially in their loan-to-value (LTV) ratios, so it is a good idea to shop around for a construction loan. A lender is most likely to finance just 50-60 percent of a project. You may be able to find an offer for greater LTV, however. Market conditions have the greatest effect on LTV, but your qualifications and loan condition, such as recourse (whether or not you, the borrower, will be held personally responsible for the debt), also play a role.
Most lenders will be happy to pre-qualify you based on basic information you supply, and then present an estimate of the loan amount and conditions they can offer. The formal application process will be much more complex and may require you to make critical decisions concerning issues such as recourse and fixed vs. variable interest rates. You will almost certainly need a lawyer and accountant to help you come to an agreement with the lender on the on terms of the loan.
You will be asked to provide detailed information about your finances. The lender will evaluate your financial preparedness for the loan and consider indicators such as your debt service coverage ratio (DSCR). This is a measure of your ability to make payments based on a comparison between your cash flow, some—possibly much—of which will be theoretical at this point, and the debt you are taking on. Your personal and business credit scores, as well as your experience as a developer, will also factor greatly in the lender’s final decision.
Real Estate Development Is a Team Effort
Securing construction financing is only one aspect of multifamily real estate development. A successful development project requires deep knowledge of business, architecture, construction, and property management. You’ll also want to have a strong network of trusted professionals in each of those areas—people you can depend on through all stages of development. The most important member of your team will be your general contractor, whose reputation will also influence the bank’s decisions.
If you have trouble finding a lender that is willing to finance your project, or if you don’t have access to sufficient funds to make the necessary down payment, you may need to take on one or more financial partners. This is not at all unusual. Partners can provide benefits besides funding, including practical expertise, insight based on past experience, and strong business relationships with service providers and professionals. A successful partnership could lead to more joint projects in the future.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
Please contact us to learn more about investing with CWS Capital Partners, or view our current offerings by completing our self-certification form for accredited or qualified investors.
The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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