New construction loans are great for those who know how to use them effectively. Here are seven questions to help determine if going ground-up is right for you
As we enter 2020, more and more real estate investors are turning to ground up construction as a way to drive bigger profits on their fix and flip projects and single-family rental portfolios.
New construction loans are a strategy that investors need to know how to use effectively. The seven questions in this article will help you find the right ground up construction financing for your next construction project.
How is a ground-up construction loan different from a traditional mortgage product?
Ground-up construction loans for real estate investors are different from mortgages on owner-occupied properties in a few ways. First, this construction financing is a short-term loan, not a 30-year mortgage like FHA loans. The loan can be used to cover the costs of construction only, or of the purchase and construction of the property. If you choose to hold the property as a single-family rental, you may need to refinance into a permanent mortgage because the construction loan is a short-term note, unless you owned the property free and clear before beginning the construction project.
What percentage of construction funds can I borrow?
Different ground-up construction lenders offer different amounts here. Lima One Capital can lend up to 90% of lot purchase and construction costs, and up to 100% of construction cost of building if you are doing a construction project on a lot you own outright. (The loan to ARV ratio must be 70%.) As you’re comparing leverage options, make sure you understand the fee structure of the loan, what set of closing costs you need to expect, and how underwriting requirements like credit score apply.
How will construction draws work?
Different lenders use different loan processes for construction draws during a construction project. Before you borrow money, make sure you understand what documentation you’ll need to provide for each draw, what fees you pay per draw, and more. (Lima One clearly spells out our draw process in our Construction Toolbox.) This will help you ensure you have enough cash on hand to keep the project running while the draw process occurs. Also look for whether commitment funding is available. This will allow you to avoid paying interest on construction funds until you draw them.
What kind of project plan do I need to create?
At Lima One Capital, we have found that real estate investors with detailed project plans for construction have the best chance of successfully completing their projects. That’s why our construction management team works with borrowers to ensure that an accurate and feasible project plan is in place before a loan is originated. Different lenders will have different requirements in this area, so it’s important for investors to know what the requirements are so they can close as quickly as possible.
What happens if my project timeline runs over?
Too often, hard money lenders hide onerous payment requirements in the fine print of loan terms. This may be prepayment penalties, or it may be expensive loan extension terms. Construction project often run long, whether because of unavoidable weather delays, extended permitting processes, or unreliable general contractors and subcontractors. Don’t leave this to chance—know what will happen if the worst-case scenarios push out your timeline.
What do I do if I want to turn the property into a rental?
You may start a construction project with the intention of selling it, but market changes indicate that you’ll be better served turning the property into a rental. You need to know what construction to permanent loans are available. Being able to work with one lender to quickly refinance into a 30-year loan can help you save time and money. Lima One Capital even offers Build2Rent, a single-close loan that is interest-only ground-up construction financing while you’re building, and then can convert into a 30-year loan. Knowing what your options are before you begin will help you adjust quickly if a change in tactics is necessary.
What support will I get to ensure my project runs smoothly?
This is a key question that investors sometimes overlook when choosing the loan, the lender, and the interest rate they prefer. Does your lender service the loan and the construction draw process? Or will a third party with no context and little investment in your success manage things? Lima One Capital chooses to service all the loans we originate (including construction draws) so we can support our clients throughout the process and celebrate the conclusion of the project, not just the origination of a loan.
Conclusion
When you find a lot that makes sense as a ground-up construction project, use these FAQ to find the right construction loan for your needs. Of course, the Lima One Capital team is happy to discuss your project to find the right financing fit. Contact us to start the conversation today.
Rob Parsley is the western division regional sales manager for Lima One Capital.
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