What is a commercial construction loan?
A commercial construction loan finances new commercial building construction or major renovation. Loans typically structure as: 12-24 month construction phase with monthly interest-only draws, followed by conversion to permanent take-out financing OR balloon payoff. Most construction loans require 25-35% borrower equity, 680+ credit, signed construction contracts, builder qualifications, and detailed budgets. Rates: 6-12% APR during construction. SBA 504 offers 10% down for owner-occupied construction.
Commercial Construction Financing Overview
Commercial construction loans fund the development or major renovation of commercial real estate. Unlike a permanent mortgage, construction loans are short-term (12–36 months) and disbursed in stages (“draws”) as construction milestones are completed. When construction is complete, the loan converts to or is replaced by permanent financing.
Types of Commercial Construction Loans
Construction-to-Permanent Loans (C2P)
A single loan that covers both construction and permanent phases. During construction: interest-only payments on drawn amounts. After completion: converts to amortizing permanent mortgage automatically. Saves on closing costs vs. two separate loans. Best for owner-occupied commercial properties.
SBA 504 Construction Loan
The SBA 504 program covers ground-up construction and major renovations for owner-occupied commercial property. Structure: 50% conventional lender + 40% CDC + 10% borrower. The SBA portion locks in below-market fixed rates (typically 6.5–9%). Up to $14M total project with $5.5M SBA portion.
Conventional Construction Loan
Bank-provided construction lines of credit disbursed against inspected milestones. Typically 70–75% LTC (loan-to-cost) or 65% LTV (loan-to-value) of completed appraised value. 12–24 month term, Prime-based or SOFR-based floating rate. Requires experienced general contractor and architect’s plans.
Key Requirements for Commercial Construction Loans
| Requirement | Standard |
|---|
| LTC (Loan-to-Cost) | 65–75% of total construction costs |
| Contractor Experience | Licensed GC with commercial track record |
| Plans & Permits | Full architectural plans and permitted drawings required |
| Personal Guarantee | Required for most SBA and conventional construction loans |
| Pre-Leasing | 30–50% pre-leased preferred for investment properties |
| DSCR (Permanent Phase) | 1.25+ on stabilized cash flow |
Frequently Asked Questions
How does a commercial construction loan work?
Construction loans fund in monthly draws based on construction progress: foundation, framing, roofing, mechanical/electrical/plumbing, drywall, finishes, certificate of occupancy. Lender (or inspector) verifies progress before each draw. Interest accrues only on amounts drawn. Loan converts to permanent financing or refinances at completion.
What's a construction-to-permanent loan?
A construction-to-permanent (C-to-P) loan combines construction financing with permanent take-out financing in a single closing. During construction: interest-only payments on draws. At completion: automatically converts to permanent amortizing loan (15-30 year). Single closing saves 1-3% in fees vs separate construction + take-out loans.
How much down payment do construction loans require?
Conventional commercial construction: 25-35% down. SBA 504 construction (owner-occupied): 10-15% down. SBA 7(a) construction: 10-20% down. Stronger borrowers and properties get lower down payment requirements. Special-use properties (hotels, medical) may require 30-40% equity.
What's the difference between hard cost and soft cost?
Hard costs: physical construction — materials, labor, fixtures, equipment. Soft costs: design, permits, legal, financing fees, interest reserve, environmental studies, real estate taxes during construction. Most construction loans cover both, but require detailed breakdown. Soft costs typically 15-30% of total project cost.
Do I need a construction contract for a loan?
Yes — most construction loans require: signed construction contract with general contractor (lump sum or guaranteed maximum price preferred), builder qualifications and references, detailed project budget, completion timeline, and contingency reserve (typically 5-10% of hard costs). Cost-plus contracts are usually disfavored by lenders.
How is the construction loan repaid?
Options: (1) construction-to-permanent loan auto-converts to amortizing loan at completion, (2) balloon payoff from sale of property, (3) refinance with permanent loan (bank, SBA 504, or commercial mortgage), (4) lease-up and refinance for income property. Plan the take-out strategy before construction starts.
MW
Marcus Webb
Certified Lending Professional (CLP)
CLP Certification, 14 years commercial lending, SBA loan origination
Marcus Webb is a Certified Lending Professional (CLP) with 14 years of experience in commercial lending and SBA loan origination. He has helped over 2,000 small businesses secure financing ranging from USD 50,000 to USD 5,000,000. Marcus holds a Bachelor of Finance from NC State University and the American Bankers Association Certified Lender designation.
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