Commercial Construction Loans: How Proceeds, LTC, and Draws Work

Commercial construction loans are used to finance new real estate development projects. They may also help fund land acquisition as part of the construction process, depending on the project, lender, and capital structure.

Construction financing is different from stabilized property financing because the lender is not simply underwriting an existing income-producing asset. The lender is underwriting a project that must be built, completed, and eventually stabilized or sold.

Randy Efron of Skylatus Property Capital explains that construction loans are generally used to construct buildings, but in some cases they may also be used to acquire land as part of the overall development plan. In many projects, however, the developer already owns the land because the approval and entitlement process can take a long time.

For sponsors evaluating ground-up construction financing, understanding how lenders size proceeds, how loan-to-cost works, and how funds are disbursed through draw requests is essential.

What Are Commercial Construction Loans?

Commercial construction loans are short-term real estate loans used to finance the development or construction of a property. Unlike a permanent loan, which is typically secured by an operating property with existing income, a construction loan supports a project while it is being built.

That means the lender must evaluate the full development plan, including budget, timing, sponsor experience, property type, land basis, and the likely exit strategy once the project is completed.

A construction loan may be used for different types of commercial real estate projects, including multifamily, hospitality, single-tenant net lease, mixed-use, or other income-producing property types.

Can Construction Loans Include Land Acquisition?

Construction loans can sometimes include land acquisition as part of the construction process. However, in many real estate development projects, the land is already owned by the developer before the construction loan is arranged.

This often happens because development approvals, zoning, permitting, and other pre-construction requirements can take a long time. A sponsor may acquire land first, complete the approval process, and then seek construction financing once the project is closer to being shovel-ready.

In some cases, if the developer purchased the land earlier and the land value has increased, a construction lender may give the developer credit for that value increase when calculating project cost. When that happens, the effective loan-to-cost ratio may be higher than the lender’s stated advance rate on actual cash basis.

Common Types of Construction Lenders

Generally speaking, banks are among the most common providers of construction loans. Bank construction loans may be attractive because they can offer a lower cost of capital compared with private lenders.

Private lenders, including debt funds, also make construction loans. These lenders may be more aggressive in loan sizing, but they usually charge a higher interest rate than banks.

The right lender depends on the project, property type, leverage request, sponsor profile, timeline, and overall business plan. Sponsors should evaluate not only the amount of proceeds available, but also the cost of capital and execution risk.

How Loan-to-Cost Ratios Work

One of the most important sizing metrics for commercial construction loans is the loan-to-cost ratio, often abbreviated as LTC.

According to the transcript, aggressive banks may size construction loans around 65% to 70% of a project’s cost. Private lenders such as debt funds may be more aggressive and can sometimes push loan-to-cost ratios into the 75% to 85% range.

Higher leverage can be attractive to developers because it may reduce the amount of equity required. However, higher leverage usually comes with a higher cost of capital and potentially tighter lender controls.

Banks vs. Debt Funds for Construction Financing

Banks and debt funds can both provide commercial construction loans, but they usually differ in cost, leverage, and flexibility.

Randy Efron notes that a bank loan may have an interest rate in the fours, while a debt fund loan may have an interest rate in the sevens. The exact terms will vary by market, sponsor, project, and lender, but the broader point is that private capital is generally more expensive than bank financing.

How Construction Loan Draw Requests Work

Construction loan proceeds are typically not disbursed all at once. Instead, funds are released over time as the project progresses.

As construction advances, the borrower submits draw requests to the lender. The lender reviews those requests and then disburses funds based on the approved construction budget and the work completed.

Draw requests usually include an accounting of actual expenses compared with budgeted expenses. They may also include lien waivers from contractors and borrower attestations.

This staged process helps align loan funding with project progress. It also helps lenders manage risk by reviewing construction activity before releasing additional proceeds.

Specialized Construction Loan Products

Not all construction loans are the same. Certain property types may qualify for specialized loan products.

For example, multifamily construction may be financed with HUD-insured loan programs, depending on the project and eligibility requirements. Sponsors evaluating apartment development may also want to review broader multifamily financing considerations.

Single-tenant net lease properties may also be financed with high-leverage build-to-suit loans in certain situations. For sponsors focused on that asset class, Skylatus’ single-tenant net lease expertise may be relevant.

The important point is that construction financing should be matched to the asset type, business plan, and exit strategy. A generic construction loan may not be the best fit for every project.

Why Project Cost and Land Value Matter

Project cost is central to construction loan sizing because it affects the loan-to-cost ratio. Project cost may include construction costs, land basis, soft costs, and other development-related expenses, depending on the lender’s underwriting approach.

Land value can be especially important when the developer bought the land before completing approvals. If land value has increased since acquisition, some construction lenders may give credit for the increased value and include it in project cost.

That can change the way the loan-to-cost ratio is interpreted. The stated loan-to-cost may appear to be within the lender’s target range, while the effective leverage relative to the developer’s original cash basis may be higher.

How Construction Financing Fits into the Capital Stack

A construction loan is only one part of the broader capital stack. Developers may also need sponsor equity, third-party equity, preferred equity, mezzanine debt, or other forms of capital depending on the project size and lender requirements.

That is why it is useful to evaluate construction financing alongside the full range of available types of capital. A project with a lower-leverage bank loan may require more equity, while a higher-leverage debt fund loan may reduce the equity requirement but increase debt service and overall financing cost.

The right answer depends on the project’s economics, timing, risk profile, and business plan.

Practical Takeaways for Borrowers

Borrowers seeking construction financing should understand how lenders think about cost, proceeds, and disbursement risk.

• Commercial construction loans are used to finance building projects and may sometimes include land acquisition.
• Banks are common construction lenders and may offer lower-cost capital.
• Debt funds may provide higher loan-to-cost ratios, but usually at a higher interest rate.
• Loan-to-cost is calculated by dividing the loan amount by total project cost.
• Land value increases may affect how certain lenders calculate project cost.
• Construction loan proceeds are typically released through draw requests as construction progresses.
• Draw requests commonly include expense details, lien waivers, and borrower attestations.
• Different property types may qualify for specialized construction loan products.

For sponsors evaluating construction financing, it may also be useful to review Skylatus’ broader property expertise, closed deals, and case studies.

Conclusion

Commercial construction loans are designed to fund real estate development projects, but they are more complex than simply borrowing money against a completed building.

Lenders evaluate project cost, loan-to-cost, land value, sponsor experience, draw requests, and the path to completion. Banks may provide lower-cost capital, while debt funds may offer higher leverage at a higher cost.

For borrowers, the key is to understand how loan proceeds are sized and how the draw process works before selecting a capital source. The right construction financing strategy should match the project’s budget, timeline, property type, and overall business plan.

Skylatus Property Capital helps real estate sponsors evaluate construction financing and broader capital strategies for development projects.