by New Wave Loans | May 6, 2022 | Loan Programs, Loan Resources
Real estate lending can be complex as there are multiple loan options available. However, the variety allows investors and property developers to choose an appropriate loan depending on the costs of a specific project and available funds. A good understanding of the intrinsic differences and characteristics of available options can help you make a good decision.
Bridge and construction loans are common hard money loans that you can tap into when undertaking a real estate project. Therefore, it’s prudent to understand the differences.
What is a Construction Loan?
Construction loans are often issued against real estate value when funding new projects. Typically, these loans provide the money for purchasing shovel-ready land. It covers the costs of buying the land and building a new property. New construction projects tend to be more expensive than purchasing an existing property.
Most lenders design the loan structure based on construction reserve accounts depending on the property value and potential loan risks. Approximately 10% of the total loan cost is used to cover the costs associated with potential risks.
The defining factor is that construction bridge loans are not disbursed in full when closing the borrowing process. Instead, the funds are released in stages depending on the construction budget. Also, the loan has a pre-funded interest reserve account to issue payments when construction is ongoing. After the construction phase, the loan is paid back with a refinance.
The term and total loan amounts depend on construction cost, but it’s usually between 12 and 24 months. The loan only attracts interest during the construction phase, but it includes a non-material execution risk.
What Is a Bridge Loan?
Bridge loans serve a vital need in the real estate industry for people selling a home to purchase a new one. It is a short-term loan that provides the funds for buying a home before selling your current home. Bridge loans for new construction reduce the hassles of looking for a house when your home is on sale. Since the loans are short-term solutions for home buyers, the loan term is about six months. Also, bridge loans have higher interests than traditional loan options.
The real estate market can be competitive, and buyers need to act quickly once they find a suitable house. To secure a good property, home buyers use a bridge loan in the short term before refinancing with a long-term loan. The typical interest rates depend on the value of the real estate property and the creditworthiness of a borrower, but it’s about 1% higher than conventional loans. A peculiar characteristic of bridge loans is that the borrower uses their current home’s equity when purchasing a new house.
Bridge Loan vs Construction Loan
It can be challenging to distinguish between types of loans that sound similar, like a bridge loan vs construction loan. While they can be categorized as hard money loans and look like they are used for similar needs, the loans have distinct characteristics.
Construction Loans vs Bridge Loans Uses
Typically, retail apartment construction bridge loans are used to purchase a property where new construction will start or an existing building that will be demolished to pave the way for new construction. On the other hand, bridge financing can be used to purchase a construction-ready property, but it can also be used to acquire a property that needs slight home improvements before flipping at a higher amount.
Moreover, bridge loans are a temporary financial solution for individuals who want to buy a property quickly before securing long-term financing or a line of credit.
Construction Loan vs Bridge Loan Repayment
In bridge loans, the amount is paid back using a long-term financing option taken later. On the contrary, borrowers pay back a personal construction loan after completing the construction and selling the property. As such, bridge loans have a shorter repayment time compared to construction loans.
And while the two funding options may seem to overlap, the terms determine how borrowers can use the money. Ideally, bridge financing doesn’t cater to construction costs since its primary use is property acquisition. On the contrary, construction loans are a better option for developers who need money to build a real estate investment property.
When Should You Use a Bridge Loan?
Bridge financing is suitable when you need financing for the short term before you find long-term funding options. The loan comes in handy when you want to acquire a property quickly, especially when dealing with a competitive market. Since mortgage bridge loans are more flexible, an investor can refinance with a long-term home equity loan when all permits and documentation are ready.
Additionally, developers targeting construction-heavy projects for commercial use can leverage a bridge loan to acquire the property. This is because a hard money loan has a 12-month term, making bridge money an appropriate option before getting all the necessary zoning and approvals. After acquiring the property and getting everything in place, it becomes easy to refinance with a less-costly financing option.
A bridge loan is often used to cater to various costs, including:
- The costs of urgent closing costs and deadlines
- Property rezoning
- Soft costs before residential flipping
When Should You Use a Construction Loan?
A construction loan is appropriate when a real estate investor wants to buy a shovel-ready property. The funding takes care of the costs of acquiring the property and starting construction work. In addition, this type of funding can be suitable for a developer who wants to buy a distressed property to tear down and rebuild a new property. Whether it’s a dilapidated property or a mold-laden house, an investor can use a construction loan to buy and remodel the property before selling it at a profit.
A construction loan can be a good option if you already have a property and the necessary permits to begin building new structures. Typically, getting the permits for new construction can be an uphill climb, but if you have the documentation ready, construction financing can provide the money needed to kick start the project. This type of financing can be used to cover various costs, including:
- Cost of buying land
- Building materials
- Contractor expenses
- Construction permits
Bottom Line
The real estate landscape can be complicated if you don’t have sufficient funds to finance your project. But there are several hard money options you can leverage when you want to venture into real estate investment. Bridge loan vs construction loan are among the great funding options for real estate investors and developers.
by New Wave Loans | May 6, 2022 | Loan Programs, Loan Resources
When developing your next residential or commercial property, lots of processes and on-site activities need to be done. One of the most challenging steps in the development process is securing the right financing, called developer land loans, to fund the project from start to finish.
These loans can be used to acquire and improve the land or/and construct structures and buildings on the land. We have covered more about developer land loans in the subsequent sections below.
What are Land Developer Loans?
Development loans are funds obtained from a bank, private lender, or other financing sources to improve a piece of land. These loans can be used to acquire, subdivide, construct or renovate a parcel of land/property. Real estate development loans are available for both residential and commercial property developers.
There are different types of development loans, and you can pick one depending on your unique needs. For instance, acquisition and development loans will see you buy and improve the value of the land. On the other hand, construction loans will cover all expenses that involve the setup of structures and buildings. Below are the main types of developer land loans.
4 Types of Development Loans
Acquisition Loans
These are loans used to finance the purchase of an undeveloped parcel of land. Acquisition loans do not offer much except buying a piece of land; hence, they are less popular among investors. Serious property developers who want a quick return on their investment will choose to buy the parcel of land using their own money before securing a substantial development loan.
This reduces the number of active loans that could hurt your credit score. Plus, you’ll only need to deal with a few lenders instead of several lenders with varying loan rates and terms.
Development Loans
Unlike an acquisition loan, land developer loans are designed to fund improvements on the land. These would include site clearance, leveling, building roads, connecting sewers, water lines, etc. Most developers refer to these improvements as horizontal improvements. And since development loans improve the value of the land, they are more common than acquisition loans. However, they aren’t as popular as construction loans.
Acquisition & Development Loans
As the name suggests, A&D loans are meant to acquire a piece of land and develop/ improve it. An acquisition and development loan is one of the most versatile loans since it serves two purposes at once. The loan amount will include the cost of the undeveloped land and other expenses such as horizontal improvements, interest reserve, sales commissions, and contingency reserve. Most private lenders will require investors to make at least a 30% down payment in cash to qualify for the remaining 70% of the loan. However, this isn’t guaranteed as some lenders will not exceed the 50% loan-to-value range.
Construction Loans
These loans are meant to finance the building or renovation of a real estate project. It’s one of the most popular development loans among property developers. Construction loans differ from the other development loans in that you’ll receive the money not as one lump sum but in monthly draws. Most lenders will fund up to 70% of the construction project only if it’s well-conceived. This is especially true if the developer has a proven track record in the real estate space.
How to Get a Real Estate Development Loan
Before we look at how to get started with a real estate development loan, it’s important first to understand the financing options available. In other words, where can you secure your construction or acquisition and development loans? Ideally, there are several ways to fund your real estate project, from land acquisition and improvement to development. However, the most popular financing options are:
Traditional Financing
Here, the lender is a bank that assesses the risks of funding the project based on several factors. These factors include the likelihood of the project’s success and the developer’s credit history and real estate experience. Most banks will finance 60% to 80% of the project’s cost. That means the developer must seek alternative means to fund the project fully.
Private Money Lenders
These are private companies that lend money to real estate investors at a fee, typically 6% to 15%. Most private lenders have a repayment period of 12 to 36 months. But with the option to extend the repayment period up to three or even five years. A private lender will often fund 25% to 50% of the total cost of developing the real estate project. The benefit of this financing option is the quick processing speed, flexibility, and convenience.
Private lenders don’t focus much on credit history, which is a huge plus for some investors. Instead, they may use the property under development as collateral. This comes with some risk, so this option is best for investors developing projects for quick sale. Or those with other ways of repaying the huge debt within the stipulated time.
Crowdfunding
This is a way of pulling resources from investors who are willing to participate in a real estate project. Thanks to the current legislation, these investors don’t need to be people in the developer’s close circle. Nowadays, developers can crowdfund through social media and get investors willing to invest in their projects. This is also a great opportunity for the less capitalized investors to venture into projects historically reserved for the wealthy.
Sponsor Equity
A real estate sponsor is the individual or team that takes an active lead on a real estate development project. These sponsors must outlay their capital during the initial project feasibility and other site evaluation activities. The best type of sponsor equity in commercial real estate is the one that brings hard cash equity. However, most sponsors don’t have 20 to 40% of the project’s cost in cash. So many sponsors will eventually turn to other equity financing options.
Getting Started with Real Estate Developer Land Loans
Securing a real estate development loan can be hectic, but it doesn’t have to be. The options we have highlighted above aren’t exhaustive but are the most popular in the market. Here are some critical factors to consider when choosing a real estate development financing option.
- Conduct proper research and feasibility study. Preliminary due diligence against potential challenges and associated financial costs are key to successful real estate development. Always consider the micro and macroeconomic factors that may impact the project’s profitability.
- Have an accurate budget and list of expectations. A high degree of accuracy is crucial when building development budgets. Whether you are applying for a construction or subdivision development loan, poor budgeting can jeopardize the whole project. Similarly, you should have realistic expectations when applying for land developer loans. Having contingency plans and embracing a flexible mindset is also important.
- Balance debt and equity. Leverage is great until the banks or private lenders aren’t comfortable funding your projects. Instead of going all-in with debt, consider building your equity as well. This will positively impact your ability to finance future projects.
- The overall cost of the loan. The real estate investing landscape is complex and requires the right mix of skills and experience. Not all the financing options will work for your development project. One factor to keenly consider is the cost of the loan. If the loan is too expensive to bear, you should rethink your investment options.
Make a Leap in the Right Direction
Developing a real estate project from scratch is time and resource-intensive. Having the right financing options is key to the success of the entire real estate project. To boost your odds of success, consider the financing options we’ve identified above. Similarly, take your time to do proper research, streamline your budgeting, and balance your debt and equity.
