Construction funding guide for business projects
- Red Building loan interest rates vary depending on the size of the project and the risk to the lender
- Amber A common construction loan structure is for funds to be released in stages
- Green Construction finance lets a business take on much larger or multiple projects
Let Alternative Business Funding get you up to speed on all the options for investing in or securing investment for your construction business.
What is construction finance and why use it?
Construction finance helps businesses fund their building projects and make their vision a reality. Construction loans are a kind of short-term finance, typically used when erecting a new building on a vacant site or substantially altering an existing property.
Doing building work on finance lets a business take on much larger projects than it could normally with just the funds on hand. It can also allow a business to take on multiple projects, though lenders may be concerned if it looks like you’re taking on too much at once.
How does construction finance work?
Many types of finance can help contractors, developers or businesses needing to build.
A construction loan is usually taken for a short term, often about a year, and is issued to cover the costs of building a structure on an undeveloped property. The amount of finance offered is based on the projected value of the developed property (gross development value or GDV), which is used to secure the loan.
Once the structure is complete, the property can be sold and the loan repaid, or financing can be switched to a mortgage or another long-term option.
A common construction loan structure is for funds to be released in stages, based on milestones in the project. Common stages for release may be:
- Loan approval
- Completion of foundation
- Completion of structure framing
- Completion of roof and walls
Different disbursement terms may be negotiated with lenders, just be very clear what qualifies each stage as ‘complete’.
If you are a builder or subcontractor and you do not own the property you are working on, you may still need finance to do your job. Payment terms in the industry, often as long 90 days or more, mean you may be spending substantial amounts on materials and wages during a project. Factoring for construction subcontractors, also known as invoice financing or cash flow finance, allows you to sell your outstanding invoices, albeit at a discount, to give you quick access to funds.
If you need additional equipment, such as vehicles or construction machinery, equipment leasing, vehicle leasing or asset finance are options for these types of acquisition.
Other types of finance, such as business loans or unsecured loans can also be used to pay for construction projects, assuming you can secure them. However, repayment terms may not be suited to a project that will not generate income for some time. Because of how business loans work, they can offer substantial advantages on such projects.
What are the costs of construction finance?
Building loan interest rates vary depending on the size of the project and the risk to the lender. Most lenders will loan up to about 70 per cent of the GDV (the value of the project once completed). For an established builder or business, with a good credit history, the interest payable may be only a few percentage points above the lowest rate available for commercial borrowing. For small projects or those assessed as higher risk, the interest rate may be substantially more.
Arranging building finance can come with a number of fees as well. Some of the more common are arrangement or set-up fees, exit fees (payable at the close of the loan) and broker fees (if you used a broker to arrange finance). Valuation fees and professional fees (architects, surveyors etc) are additional costs you must consider when undertaking construction.
Be sure to shop around and check with different construction finance companies to ensure you get the rate and terms that best suit your circumstances. Construction factoring rates, for example, can vary depending on volume and risk. Vehicle finance rates and asset finance costs are affected by the terms of the finance agreement.
How long does it take to secure construction finance?
If you have a detailed plan for your construction, clear timelines, realistic GDV assessments and a good credit history, it is possible to secure construction finance in as little as 24 to 48 hours. If your project is higher risk or you do not have all necessary documents ready, expect to wait longer.
There are banks that provide construction loans, but also consider specialist lenders. Commercial construction loan requirements can vary depending on the risk appetite of the lender. You should therefore find a company that understands your needs.
What type of security do I need for construction finance?
Qualifying for a construction loan certainly has its challenges. Fortunately, due to its nature, construction finance rarely requires you to offer any additional security. The loan is usually secured by the property being developed.
In the case of asset finance, equipment leases and vehicle leases, those are typically secured by the asset being financed and do not usually require additional security.