Is A Construction Loan The Best Option For You?
By Paul Esajian on March 10, 2014
What makes investing in real estate so great is that when one door closes another one usually opens up. If you are in an area where inventory is low or sales prices are flat, one alternative you have is to look at construction options. Building a property and applying for a construction loan is very similar to branching out to commercial properties for investors in that it is an area that is largely ignored. It may seem like an intimidating process ,but like any other area of investing, once you know the process and the steps involved it really isn’t that difficult. A new construction loan may pay off for those who know how to handle them.
The very first step is to buy the land or the lot. Assuming you have this part out of the way, you can move to the construction phase. You can get your construction funds either through private money lenders or through a traditional bank loan. If you go the bank route, you have to be ready to go through a long process of providing plans for the property, estimates, time frames, photos and many more documents and numbers. The lender will provide funds based on your ability to repay, but more importantly, the projected value of the property and your assets available.
Unlike traditional bank loans, a construction loan is given in a series of draws for every step of the way. You may get a draw for some initial process that you need done. When it is completed, you will have an appraiser, inspector or someone provide the lender documentation that has been completed and move on to phase two. The payments are usually interest only and only meant to be paid over the relatively short term. Most construction loans are six to twelve months maximum and will increase after that time. The goal is to get in and get out as quickly as possible. Whether this happens or not, is up to you, your general contractor and their crew.
Unless you are a licensed general contractor ,you will need to find someone that is to receive the draw and do the work. This can be a very intimidating process, but if you have a reliable contractor to do the work and stick to a tight budget building is not much different than doing a rehab with more work. Obviously there are more steps along the way and plenty of more red tape, but the same principles are in place. You need to follow your budget and get the house completed as quickly as you can. Every day to completion is costing you money. The longer you go without selling, the longer your money is tied up. If you are looking to get in and get out in 30 days, obviously building and construction loans aren’t for you.
The major risk with any building loan is that the market shifts from the time you start till the time you are finished. If you project a finished value of $250,000 and the market is only yielding properties for $225,000, you are staring at a loss. But, if you know your market and do good work at a good price there is money to be made with construction.