Construction Loans and Guaranties

What to expect from the lender?

Construction loans have a different risk profile from a mortgage lender due to several factors, such as: no cash-flow during the construction process, the possibility of the project not being completed and the risks of liens for labor and materials being filed against the property. This means construction lenders will require some guaranties from the borrower’s principals, including a completion guaranty, environmental indemnity, a carry guarantee, and full or partial payment guaranty from creditworthy parties.



Private Equity Funds will look to the developer/builder partner to provide all the personal guaranties required by the construction lender.



Completion Guarantee



Construction lenders will require a creditworthy party to deliver a completion guarantee. This guarantee provides that the guarantor will guarantee the complete performance by the borrower with the terms in the loan agreement with respect to the project such as: architectural design, construction specifications, amenities, etc.



The guarantor will be responsible for a lien-free completion, cost overruns and all other costs non construction-related such as: interest charges, insurance premiums and real estate taxes.



Carry Guarantee



This guarantee may cover payments to the lender of all the regular interest.  Default interest and late charges on the loan, principal and interest payments and the costs and expenses associated with maintenance and operation of the property.



Payment Guarantee



The obligations under this guarantee may cover all principal, interest and other indebtedness and liabilities of borrower in connection with the loan. Depending on the facts and circumstances of the project and the sponsor, the lender may agree to limit the payment obligations of the guarantor to a percentage or amount of the outstanding principal of the loan, plus accrued and unpaid interest, and any expenses in enforcing the guarantee.



Financial Covenants



The construction cost of the project, equity, loan amount and the financial condition of the borrower are an important part of the underwriting process, and those are relevant to the construction lender to determinate the financial covenants that might be imposed on the guarantor.



Comments



Construction lenders face risks that are not associated with loans secured by stabilized income producing properties, and those risks are mitigated with guarantees from the borrowers/sponsors. Since each construction loan is unique, those may require more than one guarantees to cover the obligations of the borrower. Those guarantees are intended to provide some level of comfort to the lender that the project will be completed according to the design, specifications, within budget, schedule, without liens, and that the loan will be repaid on time.



Capital Insiders



With over two decades of “boots on the ground” expertise, including; developing, building, owning and managing real estate, we are well versed in the RE industry and understand the needs and goals of our clients. Our team is willing and able to assist in every step of the loan process, starting from the preliminary feasibility study, to the loan closing.



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