Construction Loans 101:
Your Guide to Financing a Multifamily Property

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Putting all the pieces together to finance a multifamily property project—especially for the first time — can be daunting. While there are plenty of get-rich-quick-property-flip schemes out there, there are few reliable resources for small building owners interested in realizing steady profits through responsible long-term ownership.

The complete CPC Start Small Guide to Financing Small Multifamily Building Projects gives you comprehensive knowledge to navigate financing a small multifamily acquisition, refinance, rehabilitation or new construction project. Download your exclusive copy to reference any time. Or, for an immediate dive, continue reading on.

Putting all the pieces together to finance a multifamily property project—especially for the first time — can be daunting. While there are plenty of get-rich-quick-property-flip schemes out there, there are few reliable resources for small building owners interested in realizing steady profits through responsible long-term ownership.

The complete CPC Start Small Guide to Financing Small Multifamily Building Projects gives you comprehensive knowledge to navigate financing a small multifamily acquisition, refinance, rehabilitation or new construction project. Download your exclusive copy to reference any time. Or, for an immediate dive, continue reading on.

  • Owning property and developing real estate is entrepreneurial in nature and some level of risk comes with the territory. Through knowledge, partnerships and patience, developing or owning rental property can be both financially and personally rewarding. Our advice: start small.

    Although every project and borrower is unique, small building projects (generally with 5 to 49 units) tend to have one thing in common: they serve as an entry point for multifamily real estate professionals. Because of their size, small building projects are a practical first step for new owners interested in growing their real estate development knowledge and experience.

    While developing, owning and managing small buildings is not always simple, small building developers and owners are some of the most important providers of rental housing in the United States. Small buildings make up the majority of the multifamily rental housing stock in this country, and it is because of the energy, entrepreneurship and talents of owners and developers that so many people have places to call home.

  • When considering taking on a small building project, it is important to know all four phases involved for financing. Below is a quick overview to map out the key steps:

    PROJECT FEASIBILITY & PREDEVELOPMENT

    • This is the research, due diligence and information gathering phase to optimize your project and determine viability.
    • Consider your team. A range of expertise is needed to develop and maintain small multifamily buildings. Identify supporting experts who will complement your skill set.
    • Assess the site and project, including the physical needs of a site, researching market and municipal considerations and understanding how these affect the bottom line.
    • Explore financial options and the process of working with a lender.

    CLOSING

    Examine the paperwork needed to close and what to expect on closing day, such as commitment letters, common documents and legal considerations/costs.

    CONSTRUCTION & REHABILITATION

    Learn the standard requirements of a construction loan, including the requisition process, change orders and converting to a permanent mortgage.

    PROPERTY MANAGEMENT

    Ensuring a small multifamily building is occupied and in good health requires ongoing work, including marketing and renting units, hiring a property manager and maintaining your building. Management of these elements determines the long-term profitability of your business.

    Download the Small Multifamily Building Project Financing Process Map

  • Understanding profitability and the financial risks of owning a property is key to establishing a construction budget and making your small buildings business work.

    INCOME

    Multifamily rental properties generate income from residential rents and, in some cases, activities within the building, including retail or office rents, parking fees, laundry, cell towers or air rights. Mixed-use properties require additional information gathering because commercial rents are calculated on a square-foot basis and can vary based on access to foot traffic, transportation or available parking.

    EXPENSES

    Every building has costs associated with keeping it stable and well maintained. These include items like repairs, utilities, taxes, snowplowing or shoveling. If your property has a commercial or retail unit, preparing for a tenant may add costs.

    NET OPERATING INCOME (NOI)

    What is left over from your income after vacancy loss and expenses is net operating income (NOI). A portion of NOI will become your profit. NOI will also be the source of funds to make distributions to project investors and to repay your permanent mortgage or debt service. Because of this, lenders go through a vetting process called underwriting to determine how much they are willing to lend. This is based on how much NOI is projected and the likelihood your building will generate this same amount every month.

    CONSTRUCTION SCOPE

    Consider the amount of construction needed for a property to be habitable. The building or lot may require work before you can start on the project as you envision it. The amount of work required can have a substantial impact on the cost of your project, and therefore the feasibility of the project itself.

  • A viable project requires the right team skills, market and municipality, plus adequate financing to cover all costs. Whether it’s a specific building or vacant lot, a need for rental housing downtown or a building you already own and are trying to stabilize, the first step is the same: determining project feasibility.

    This phase is for information gathering, including a feasibility study, and almost always requires you to revisit your initial assumptions. Moving from an idea to reality is an evolutionary process, so you should expect that elements of your project may change and, depending on what you discover, your timeline could be longer than you anticipated.

    Questions to consider:

    • What are the skills and expertise you need for your project to succeed? Do you need to bring in expertise to round out your own?
    • Where is the property or site? Is it in a strong or weak market? What is its condition and the associated costs?
    • What are the income and expenses for the property, including development costs if construction is needed? Do the numbers make economic sense? Do you have the required equity?

  • To own multifamily housing, you and your property development team need to have certain skills and be financially strong enough to complete any construction or rehabilitation according to a lender’s standards. You’ll also need to keep the property well maintained over the long term.

    As owner and project lead, you’re responsible for keeping the team on track. Speak to as many experts as possible to build your knowledge base and increase your network of potential team members. You’ll need to work with your lender to determine if your team’s skill levels meet your lender’s requirements around certification, training and experience. Clarify these requirements prior to adding team members.

    Common team members include architect, lawyer, licensed subcontractors, general contractor, property manager and expediter. If you’re interested in using subsidies, it’s helpful to have someone on your team who’s familiar with subsidy program requirements.

    Lenders will want to check your financial health and that of any member of your team with an ownership stake in the property. General requirements include:

    • You invest some of your own equity in your project
    • Liquid assets sufficient to meet your equity requirements, plus a cushion
    • Sufficient net worth—your total assets minus your total liabilities

    A lender may also require that you provide a personal guarantee of payment, a payment and performance bond, a letter of credit, or cash in lieu of a letter of credit.

  • If you don’t already own a property, you may want to work with a real estate professional who’s solely in the business of buying and selling properties. Alternatives to find a property or land to build on include land banks, community development (CD) offices, community development corporations (CDCs), neighborhood community-based nonprofits and municipal industrial development agencies (IDAs).

    Your building’s location has an impact on your operating costs and income. A professional market analysis will provide in-depth information, but you may find the same information online for free. You can use comparable properties (comps) to ensure you are purchasing the property at a fair price and to determine what you’re likely to be able to charge for rent. Details to research: access to transportation, local economic characteristics, zoning, demographics, crime and comparable properties’ rents, expenses, taxes, size and amenities.

    Every city has rules about how buildings should be constructed and maintained (building codes) and where they can be built (zoning), as well as preferences for development in certain areas. Because these vary greatly, your best source of information is someone who works for a particular municipality itself.

    Ballparking costs by developing pro formas helps determine if your project meets your lender’s feasibility criteria. Pro forma calculations are generally done on two separate spreadsheets referred to as “Income and Expense Statements” (I&E) and “Construction or Rehabilitation Budgets.” The projections in your initial calculations may evolve throughout the project as conditions change or new considerations emerge. For details on how to set up your I&E and Construction or Rehabilitation Budget, please download the full-length Start Small guide.

  • To secure a loan, it’s necessary to pinpoint accurate figures for income, expenses and the budget for construction or rehabilitation. Based on these numbers, a lender will determine the amount of debt your project can support.

    You’ll need to provide your lender with the I&E and Construction or Rehabilitation Budget you’ve created, along with any documentation you have that helps explain your numbers. Then your lender will begin the underwriting process to assess risk.

    Because of familiarity with markets they operate in, lenders have a good sense of average construction costs and how much income a property is likely to generate. They also have standards used to assess the financial feasibility of your project.

    Based on your proposed scope of work, a mortgage construction loan officer will also have a good idea, on a square-foot basis, of what it will cost to construct or rehabilitate your building. An in-house or third-party expert will review your proposed costs prior to closing your loan to ensure they are not out of line with the project type or location. As you move ahead, this review will likely include bids of general and subcontractors, as well as signed construction contracts.

    From these underwriting findings, a lender will determine the type and size of loan that best fits your project’s needs and your goals and will set the specific terms of the loan.

  • A gap in financing occurs if there is a difference between the total cost to develop and the total amount of funding (debt plus equity). Common options to fill gaps:

    • Commit more of your own or an investor’s equity to the project.
    • Incorporate energy-efficiency measures, which will lower operational costs and increase NOI.
    • Use grants or subsidies.

    Grants come from foundations, private family offices, or city, state or federal agencies and help support their providers’ missions.

    A subsidy is funding provided by a level of government (municipal, county or state) and made available to a project because it’s been deemed by the issuing agency to provide a public good.

    • Consider tax benefit programs.

    Tax abatements reduce an owner’s local real estate taxes.

    Tax credits are administered by state and federal agencies and allow owners to obtain additional equity by selling the credits to investors, who use them to offset federal taxes.

    Payment in lieu of taxes (PILOT) is an arrangement made to compensate a local government for property tax revenue that it loses because of the tax-exempt nature of the ownership of a property or of a property itself.

    Tax exemptions reduce the value of a property for tax purposes so an owner’s tax bill is lowered, generally for a finite period of time.

  • The term of your construction or rehabilitation loan begins the day you close. Construction should be completed within the term of your loan, specified in your commitment letter. Throughout the term of your loan, you can make requisitions on a regular basis.

    A requisition is a detailed request for payment for the labor, materials and other construction costs associated with your project. Your lender will have specific forms you are required to use and deadlines by which you must submit them to be paid in a timely manner.

    The requisition process continues throughout the life of your construction loan. Creating a construction timeline with your general contractor is key to ensuring there are no delays in payment or any ripple-effect delays in your project’s completion.

    In addition to carrying out all site work, you will need to host third-party and lender site visits, conducted to ensure your project is proceeding on time, on budget and in compliance with code.

    At the construction loan term’s end, you’ll need to pay off the full amount. This is done by obtaining a permanent mortgage to “take out” your construction loan. Prior to converting your construction loan to a permanent mortgage, you need to meet certain thresholds, including proving that construction has been completed, residents are in place and the project is cash flowing.

  • An ongoing property management plan ensures your small building stays occupied, in good health and profitable over the long term.

    Screening for residents may begin prior to the completion of your scope of work. If you are managing the property yourself, you can outsource this process to a realtor, who will generally charge a fee to those they place in your units. There are legal requirements both for you as a landlord and for your building, and these can be different for your specific community, the state and the country overall. For this reason, you may want to consult with your lawyer.

    Have an application and lease ready prior to showing the units to prospective tenants. (Basic templates can be found online.) Be sure to review relevant local laws. Your state may require documentation, such as lead paint disclosure forms and window guard notices. By having these documents ready, you may be able to move faster when applicants show interest in moving in quickly.

    Decide in advance how, where and when to receive rent. Communicate these decisions both in person at the lease signing and in the lease itself. Outline in the lease any late fees, charges or steps you will take if rent is late or not paid. Lenders may ask to see a copy of your standard lease, as they have a vested interest in ensuring your property is generating cash.

    Property operation and maintenance plays a large role in the long-term stability of your property. By visiting your property on a regular basis, issues with the building and any concerns from tenants can be proactively handled.

Other Helpful Resources

Need help finding the right product?

Construction Permanent Acquisition Refinance Rehabilitation

Income & Expense Statement
Sample Budget
Case Study
Common Documents Checklist
Financing Milestones Checklist
Glossary of Terms

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