How does condo construction financing work?

Condo construction loans vary depending on the type of project, and can be one of the most difficult types of commercial mortgages to structure. Condo development projects can include highrise towers, row-townhouse projects, four-storey apartment-style projects, duplex projects, and even mixed-use developments involving a retail, office or hotel component.

Because condo construction loans involve a multitude of variables, which are at times outside of the developer's control, there are only a select number of mortgage funds who consistently have an appetite for this type of financing. The best projects are developed by developers who are able to execute on a development plan in a timely manner, and the ones who are best able to mitigate a great deal of risk. Construction lenders look to fund projects that have a strong team backing the development.

In today's current market, typical condo construction loans are structured as a function of cost and value. The borrower's equity is typically injected first, and a construction lender will undertake to fund the balance of the costs in order to complete the project. Notwithstanding the condo market in general has been quite stable across Canada even throughout the economic downturn, commercial mortgage lenders have not raced out to fund condo construction loans because of the many moving parts in financing these developments.

When making an application for a condo construction loan, it is wise for the developer to consider various elements of risk which are carefully scrutinized by any prudent construction lender. Our firm has structured over a billion dollars of condo construction loans and in every instance, the following variables were carefully considered by both developer and lender:

Construction risk:

Construction risk is defined as the risk associated with the developer or project manager failing to execute on the development of the condo project on time and on budget.

Construction risk is regarded as one of the most imperative elements in condo financing because a developer/contractor's ability to execute on a development effectively can have long-lasting implications that can result in timing delays and construction deficiencies. Because the interest-clock on construction loans don't stop until the loan is fully paid off, a borrower needs to be absolutely certain that they are able to deliver on time and on budget.

Construction risk is mitigated by experience and competency. When funding a condo construction loan, lenders will need to be extremely comfortable that the developer/contractor has the experience and capacity to complete the condo project without any surprises.

Borrowers who do not have the construction experience necessary to satisfy a construction lender will engage an experienced third-party construction management firm to help oversee the project through from beginning to end. Experienced construction management firms have the necessary track-record and understanding to keep a project in line through costing and through stream-lining the development process. A borrower can provide a construction lender with comfort that costs will not become a variable during the construction process by providing a fixed-price construction contract.

A fixed price contract with a reputable construction management company will go an extremely long way in mitigating any risk with cost overruns and deficiencies, as risk associated with variable construction costs is decreased.

Borrowers should always focus on developing a strong project budget with adequate contingencies built into them to account for cost-overruns. The project budget should be supported by quotes from various reputable sub-trades, and should never be underestimated. Managing construction risk appropriately will go a long way to ensure that a project is successfully financed by a construction lender.

To learn how to mitigate the other risks involved in this financing, pick up a copy of our November issue, on newsstands until Nov. 7.

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