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Construction financing: Prepare before you borrow

One of the best pieces of advice a loan applicant can heed when seeking financing is to be prepared. Not having the right documents in order can bring the process to a screeching halt.

That is also especially true for commercial developers. There are some similarities between securing a mortgage and a commercial construction loan. Good credit gets the best terms and interest rates. But there are some rather significant differences. And commercial construction loan applicants cannot afford to be any less prepared than those who are trying to buy a house.

Types of loans
There are two types of loans developers will need when proposing a new commercial project. First, they will need short-term financing. This covers the construction and the initial leasing. The long-term financing kicks in once the construction is completed and the property has reached a certain occupancy rate.

Connecticut Innovations, an organization formed by the Connecticut state legislature to help promising companies get a good start, noted that short- and long-term financing for a project can be rolled into one loan, called a mini-perm. That means the lender will finance the project from construction through what's called stabilization an occupancy rate for similar property types in the new construction's market.

Preliminary work
Before a commercial developer goes to a lender to apply for a loan, there is quite a bit of work to be done. Each lender is different. However, Connecticut Innovations noted that most lenders won't ask for overly detailed information about the project too early in the loan application process.

"At this preliminary review stage, the lender is usually focused on reviewing a basic outline of the project, the project cost, summary projections and underlying assumptions, and the background of the project developers," Connecticut Innovations authors Dave Barry and Jay McGuinness wrote.

When a project gets the go-ahead from this point, the lender usually begins talking terms and conditions. There is some negotiating, usually, but the terms don't have to be binding just yet.

Getting a pro forma in order 
When borrowers/developers move on to the underwriting process, that's when they will have to provide more detailed information about the project. According to PropertyMetrics, a company that makes web-based valuation and investment analysis software for commercial real estate, that kind of information will often include budget details, the borrower's financial well-being, market conditions and the project's pro forma.

A pro forma is another way of saying revenue projections. As PropertyMetrics noted, the pro forma is especially important because, unlike an investment real estate loan, a commercial construction loan has no operating history to underwrite.

A pro forma, in the case of a commercial construction project, gives revenue projections from when construction is finished and tenants have moved in. It has several components to it, including:

  • Potential income (gross): This projects the amount of revenue generated based on occupancy. As PropertyMetrics wrote that rents are calculated based on prevailing market conditions.
  • Allowance for vacancy: Since it is rare for buildings to have at least some vacancy, this is often taken into consideration in a pro forma. Can be based on market averages. Or it can be calculated more precisely, such as lost revenue when switching tenants.
  • Other income: The property may find other ways to bring in additional revenue, such as billboards or other signs on the property, parking fees or income from allowing a cell tower to be built.
  • Operating expenses: This includes all overhead. This may be salaries and benefits for property management, insurance, taxes and utilities. Property developers/owners may create a variety of lease options in which tenants pick up a portion of the operating expenses.

PropertyMetrics writes once developers have these figures, they can calculate the numbers that matter to lenders: Effective Gross Income and Net Operating Income.

To determine Effective Gross Income, developers would subtract the allowances for vacancy from potential gross income and add any other income or revenue. Subtract operating expenses from the Effective Gross Income and you have the Net Operating Income.

There are no guarantees that a high Effective Gross Income or high Net Operating Income will secure financing. But not having a detailed pro forma can hurt a developer's chances of getting a lender to say yes to a project.

When a property developer presents project details to a lender, being able to illustrate efficiency throughout can go a long way in securing financing. One of the best ways to keep a project on time and on budget is having adequate storage. Having secure storage containers on a construction site allows contractors to store important tools, equipment and materials so they don't have to be transported back and forth each day. Mobile Mini's storage solutions for construction also feature the patented Tri-Cam Locking System, which gives developers and contractors the peace of mind they need to know that whatever they have stored will be protected from theft and vandalism.