Before any successful commercial hotel construction project begins, an “A Team” should be assembled: lender, architect, and contractor. The team works together with the owner to ensure a successful project and supports the owner in decision-making. Some critical elements of all construction financings include sufficient capitalization and budget, timelines of the build-out, and the quality and strength of the contractor and architect.
When the lender “builds” the project, a number of questions must be answered. Is the contract inclusive? An experienced lender checks contingency, permits, scope of work. What is and is not included as part of the project? Landscaping, security systems and phone generally are not included in the contract. Is the property properly zoned or does it need to be subdivided? What are the timelines on zoning and permits? What fees must be paid?
Many municipalities require money up front to review drawings, go through the planning process and issue permits. What is the deadline for closing on the land or building? Many times, a lender will provide a “bridge” loan to carry the project until the permit is issued. How many months will construction take? An experienced lender will add additional months into the financing to cover any delays.
Who will be monitoring the construction process? Will qualified inspectors look at the project while it is under construction? It is in the best interest of the owner to have qualified inspectors review the work as it is completed.
In addition, inspections allow for a timely payment schedule to the contractor. How much retainage will be held? Retainage is a percentage of the contract that is held back by the lender on each “draw,” or request for payment. Retainage protects both the owner and the lender from liability as well as ensuring punch-list completion. Once all of the final punch-list items have been completed to the owner’s satisfaction, the retainage is paid to the general contractor.
How is the contractor paid? How does one ensure against mechanics’ liens? Mechanics liens are filed by the subcontractor or general contractor against the project collateral. A qualified lender will have a set payment procedure in place to ensure the contract is met and the contractor is paid in a timely manner. Generally, a contractor will be paid once an unconditional lien release is received by the bank. This ensures that a mechanic’s lien is not filed because the contractor is acknowledging that he is being paid the amount due at the time and agrees not to file a lien.
If a mechanic’s lien is filed, a lender cannot disburse any additional funds until it is cleared. This can cause significant delays to the project. Does the bank require a bond or another type of performance guaranty? If so, there are costs to the owner on these options that need to be included in the project. How does the bank approve a contractor? Lenders who specialize in construction will want to see a statement of the contractor’s qualifications, references and financials for approval of the contractor.
It is essential that a contractor and architect have hotel experience. Without it, the building will be completed to code and general commercial specifications but might not be the building the owner is 100 percent happy with; issues such as flooring, HVAC and insufficient plumbing and electrical can cause cost overruns or a miscommunication between the parties.
Finally, what type of loan will best fit the owner’s needs? Before determining loan type, the lender will need to know what type of hotel is being constructed. A conventional loan is usually the first type of loan requested by an owner. Conventional loans are completely driven by loan to value (LTV) requirements. Conventional loans on hotel projects are generally granted up to 75 percent LTV. This means that if a property appraises for $10 MM, the maximum the bank can lend is $7.5MM. The owner would essentially be required to have a down payment of 25 percent plus all additional soft costs.
If the appraisal came in lower than the $750,000, the owner would be required to put additional money down to make up the difference. Conventional loans for a construction project are allowed a maximum LTV and may or may not include an interest reserve to pay loan payments during the construction period.
Fees also may not be included as part of the project. These loans may or may not be fully amortizing and contain a call feature as part of the permanent financing. When possible, a permanent loan should be in place before starting a construction project.
The SBA 504 loan program will allow the lender to include all costs of construction. The 504 program will allow up to a 90 percent advance rate on multi-use properties and an 85 percent advance on special-use properties. This program is for “hard” assets only and will not include working capital, inventory or short term equipment. The appraisal requirement on the 504 program is for the building-to-value with all costs included except equipment. If the appraisal were to come in low, the same rules apply as to conventional loans in that the difference of the cost versus appraisal will be covered by the owner.
The 7a loan program will cover all of the costs of construction but will also allow other uses to be part of the request, such as working capital and inventory. These loans automatically convert to permanent, are fully amortizing and do not have call features. The 7a loan program also has no minimum equity requirement for an existing practice. The 7a loan is not a loan-to-value-driven program and there is no maximum LTV.
The key to a successful construction loan is to ensure that qualified people are on the team. Although the owner may receive cheaper bids, using professionals who specialize in hotel construction will end up costing less and ensure that the project is completed on budget and on time.