Construction funding encompasses two different loan periods, each with different risk levels. Most owners secure two loans, one for each period. The first is the period during construction, funded with a construction loan. The second is the period after construction, funded with a permanent loan, AKA a takeout loan. Typically, owners structure financing through a real estate holding company, which holds the construction property and the loans to limit risk for owners and their businesses. A construction loan pays for up-front project costs. In most cases, you’ll make interest-only payments during construction, meaning once construction is complete, you’ll still have to pay the full principal amount of the loan plus interest. The faster construction is completed, the less interest you’ll have to pay, and the lower your cost of capital will be.
Once construction is complete, you need your facility to reach what’s called stabilization, which happens when your facility is worth more than the initial cost of construction. Lenders consider your finished property quality collateral, so lending to you is less risky. Depending on the type of property you build, it may not achieve stabilization until it’s reached a specified level of occupancy or rental income. Stabilization occurs when the property value is greater than the initial cost of construction.