In my next blog post we are going to talk about the Loan-To-Cost (LTC) Ratio in commercial construction financing; but in order to understand that next article, you must first understand the concept of the Total Cost.
In commercial real estate finance (CREF), the Total Cost of a commercial construction project is the sum of the (1) Land Cost, the (2) Hard Costs, the (3) Soft Costs, and the (4) Contingency Reserve. By the way, you can submit your commercial construction loan request to several hundred commercial construction lenders by clicking on the button below:
The Total Cost should be at least 20% to 25% less than the completed property's fair market value upon completion; otherwise, why would the developer take on the construction risk of the project? There has to be some anticipated profit in the deal.
The Land Cost is usually what the developer paid for the land, but not always. I recently saw a commercial construction loan request in Brooklyn where the developer bought the land in 2005. Since 2005, land in Brooklyn has skyrocketed because the borough is being gentrified. Due to a material pasaage of time and some major demographic changes to the area, it would be legitimate to use the current fair market value of the land as the land cost in the calculation of Total Cost.
Another example of legitimately using a Land Cost higher than the developer's actual cost is assemblage. Suppose a developer successfully purchased three adjacent old rental houses on a busy commercial strip. With the acquisition of the land under all three houses, the developer can now bulldoze the houses and create a VERY valuable future site for a strip center. When the whole is significantly more valuable than the cost of the parts, this is an example of assemblage.
The Hard Costs are the bricks and mortar - tangible improvements that you can touch and feel. This includes line items like clearing the land, excavating the pad, grading, installation of underground utilities, the rough and finish carpentry, the rough and finish plumbing, etc.
The Soft Costs are the financial, legal, and/or paper costs of a commercial construction project. Examples include construction period interest, loan points, appraisals, toxic reports, title insurance premiums, plan check fees, permit fees, sewer hook-up fees, etc.
All commercial construction lenders require a Contingency Reserve of around 5% of the hard costs and soft costs. This reserve is designed to cover cost over-runs.
Once again, the Total Cost of a commercial construction project is the sum of the following:
1. Land Cost
2. Hard Costs
3. Soft Costs
4. Contingency Reserve