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.