Commercial construction loans provide capital for commercial construction projects. This could be, for example, a new retail, industrial or apartment building. All buildings meant for business, or as a money making company should be considered commercial use. Commercial construction loans are just one of the vehicles that may be available to a company. Other options are to sell equity capital or to repay debt by issuing bonds.
The process of getting a commercial building loan is usually much more committed than the one required for a private real estate loan. There are a number of tests banks often require upon issuing commercial construction loans. Not all banks will require the same tests, but several are very common. While a person’s credit rating is still very important, these tests are often the difference between approval and denial. In addition, they can help to fix interest rates.
The loan to value ratio is one of the tests a loan officer usually applies when processing commercial construction loan applications. This ratio should be somewhere between 60% and 85%. The difference is usually due to the type of project it is. For example, the ratio is likely to be lower for a hotel, compared to a rental house. To calculate the loan to the value ratio, divide the loan amount with the estimated value on completion. For example, a project loan of $ 850,000 (USD) can be used to finance a project estimated at $ 1,000,000 dollars. The loan to value ratio is 0.850, or 85%.
Another common test for commercial construction loan is called the profit test. If the expected profit margin on a development is too low, the risk is not attractive to the bank. In most cases, banks must see a potential profit margin of at least 20% to invest in a commercial loan. This gives enough of a pillow in case of a moderate property crash so that the bank could recover its costs. For example, if a project funded by $ 400,000 USD, the expected profit should be at least $ 500,000 USD, which would be 20%.
Commercial construction loans may also require a higher deposit than home loan, which can have a significant impact on both tests as previously mentioned. The down payment is a good way to show loan officer the developer is really invest and engaged in the project. A larger down payment will represent less risk to the bank, thus increasing the chances of a more favorable interest for the borrower.