Commercial Loans Blog

Underwriting Commercial Construction Loans

Posted by George Blackburne on Mon, Aug 25, 2014

underwriting loan commercial construction

Today we are going to teach you how to underwrite a $50 million commercial construction loan.  You will learn the six ratios that a bank underwriter will use to determine whether or not to approve your commercial construction loan request, and we are going to do this using understandable, layman's English.

Interesting note: recently closed an $18.5 million commercial construction loan on a mixed-use project in Wisconsin.  The lucky broker who brought that deal to C-Loans earned a whopping $92,500 loan fee.  Wow.  I'll betcha that fee paid some bills.  Note to self:  Submit my commercial construction loans through


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After the commercial real estate meltdown of 2008 and during the Great Recession, commercial banks had a zero appetite for conventional commercial construction loans.  By conventional, I mean non-SBA, non-USDA, and non-EB-5 loans.  In plain English, conventional here means ordinary, garden-variety commercial construction loans.  In an earlier blog post I wrote that conventional commercial construction loan requests were as welcome during the Great Recession as a male stripper at a (hetereosexual) bachelor party.  Ha-ha!

For six long years, there was very little commercial construction in the U.S.  In the meantime, many vacant and neglected commercial buildings have had their water pipes burst during a cold winter, making them essentially now almost worthless.  Other vacant commercial buildings have been vandalized and stripped of their copper wiring.  The roofs of other vacant commercial buildings have leaked, leading to dangerous black mold.  A great many productive commercial buildings became unusable.  They disappeared from the country's stock of available commercial buildings.

At the same time, the population of the U.S. has grown.  Workers are finally getting back to work.  The auto industry in America is booming again, leading to the return of many manufacturing jobs in the Midwest.  Shale oil discoveries have caused a significant migration of workers to North Dakota, Wyoming, Texas, and other oil-patch states.  Many areas of the U.S. now need new commercial buildings.

Therefore the hottest new commercial loan product right now is a conventional commercial construction loan.  And where do you find hundreds of commercial banks hungry to make conventional commercial construction loans?


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But how do you know if the commercial construction loan lead in your hand is a hottie or a complete waste of your time?  You need to know how to underwrite commercial construction loans.  This article will serve as a primer.

Conventional commercial construction loans are underwritten using six financial ratios.  The most important of these ratios is the loan-to-cost ratio.  The loan-to-cost ratio must not be confused with the loan-to-value ratio.

The loan-to-cost ratio is the construction loan amount divided by the total cost of the project.  Traditionally this ratio should not exceed 80%.  In other words, the developer is responsible for contributing at least 20% of the total cost of the project - usually in the form of free-and-clear and entitled land, with most of the architectural and engineering costs prepaid for by the developer.  Since many commercial banks are still licking their wounds from the Great Recession, many banks are limiting their loan-to-cost ratios to just 70% to 75%.  This means that the developer must modernly cover 25% to 30% of the total cost of the project.

The next ratio is the loan-to-value ratio.  The loan-to-value ratio on a commercial construction loan request is computed by taking the construction loan amount and dividing it by value of the commercial property, when it is completed and fully-leased.  The bank's appraiser will compute this value for you.  The loan-to-value ratio on a commercial construction loan request should not exceed today around 70% to 75%.

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The third ratio to look at when underwriting a commercial construction loan is the debt service coverage ratio.  The debt service coverage ratio is the property's Net Operating Income (NOI), upon completion and leasing, divided by the annual debt service (P&I payments) on the proposed takeout loan.  A takeout loan is just a permanent loan used to pay off a construction loan.  This ratio should exceed 1.25.  The good news is that with interest rates so low today, most commercial properties easily pass this test.

The next ratio to look at when underwriting a commercial construction loan is the profit ratio. The profit ratio is the difference between the fair market value of the property, upon completion and leasing, and the total cost of the project, all divided by the total cost of the project.  What we are trying to determine here is whether the developer stands to earn any profit by building this commercial building.  If not, he might be tempted to just walk away at the first appearance of a cost overrun.  The profit ratio should exceed 20% to 22%.  In other words, the commercial property should be worth at least 20% to 22% more than it costs to build.


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The next ratio to look at when underwriting a commercial construction loan is the net-worth-to-loan-size ratio.  The developer's net worth should be at least as large as the construction loan he is requesting.  A guy with a $1.5 million net worth should not be requesting a $6 million commercial construction loan.  This ratio needs to be at least 1.0.

The last ratio to look at when underwriting a commercial construction loan is the debt yield ratio.  The debt yield ratio is a brand new ratio developed after the huge losses in commercial mortgage-backed securities suffered by CMBS bond investors during the Great Recession.  The debt yield ratio is computed by taking the property's net operating income (NOI) and dividing it by the construction loan amount.  This ratio should not be less than 8.5% to 9% today.

Please note that the debt yield ratio is different from the debt service coverage ratio.  It does not look at today's low commercial mortgage interest rates at all.  In fact, this ratio was invented to rein in the excessive leverage that can occur in commercial mortgage finance when interest rates and cap rates are low.

[Editor's note:  This article was updated August 25, 2016]

Do you need a commercial construction loan or any other type of commercial real estate loan?  If so, please click the maroon button below.


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In addition to the 750 hungry commercial lenders you'll find on C-Loans, we also give away a free list of 2,000 commercial lenders.  The lenders on The Blackburne List are different from the 750 commercial lenders you'll find on C-Loans.


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Topics: commercial construction loans

Non-Recourse Commercial Loans From Blackburne & Sons

Posted by George Blackburne on Sun, Aug 17, 2014

Non recourseThis article is important to you because someday you may really-really need a portfolio commercial lender willing to make a non-recourse commercial loan.

Finding a non-recourse commercial real estate loan is far more legally sophisticated than merely finding a commercial lender "foolish enough" to make a commercial loan to a borrower who wants to reserve the right to simply walk away from his obligation.  Sometimes there are important legal reasons why a commercial loan simply must be a non-recourse loan.  We'll discuss some of these important legal reasons further below.

First of all, however, what is a non-recourse commercial loan?  A non-recourse commercial real estate loan is a loan that is NOT personally guaranteed by the borrower.  If the real estate investment goes bad, the borrower can usually simply walk away from the property.

There are around seven to ten common exceptions, known as carve-outs, to this basic rule.  If the borrower commits certain Bad Boy Acts - fraud, intentional waste (taking a sledgehammer to the walls), toxic contamination, placing a second mortgage on the property without permission, failure to maintain fire insurance on the property, failure to pay the real estate taxes, misappropriation of a condemnation award or any fire insurance proceeds, or certain criminal acts by the borrower - then many non-recourse commercial loans becomes a full-recourse loans.  The borrower becomes personally liable.

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However, absent the commission of some Bad Boy Act by the borrower, a commercial lender cannot come back after the borrower for a deficiency suffered as a result of making a non-recourse commercial real estate loan.  A deficiency is a loan loss left over after the property is sold in foreclosure.

Obviously commercial lenders are not crazy about the idea of making non-recourse commercial loans.  In fact, since the Great Recession the vast majority of all commercial banks making portfolio commercial loans today absolutely insist on a personal guarantee by the borrower.

A portfolio commercial loan is a commercial loan that the lender intends to keep in its own portfolio, as opposed to a commercial loan that the lender intends to later sell off in the secondary market.  CMBS lenders and ABS lenders (subprime commercial lenders who sell their scratch-and-dent commercial loans to Wall Street pools) are examples of commercial lenders who are not portfolio lenders.

Bottom line:  Since the vast majortiy of all commercial loans made today are made by commercial banks and credit unions, non-recourse commercial lenders are fairly rare.  If you happen to meet a commercial lender - like Blackburne & Sons - who is willing to make a non-recourse commercial loan, be sure to make a note of it.

Okay, so when is it legally necessary for a commercial loan to be non-recourse?

  1. Let's suppose you own a commercial property in your IRA.  You may not legally personally guarantee your commercial loan from the bank without running afoul of the IRS.  Personally guaranteeing your IRA's commercial loan, in the opinion of the IRS, lowers the interest rate to your IRA and is a form of disallowed contribution. (Code Section 4975(c)(1)(B))
  2. Commercial loans to Tenant-in-Common (TIC) investments must be non-recourse; otherwise the investments lose their tax-deferred qualification.
  3. Certain irrevocable trusts have a trustee who is separate from the beneficiary, such as a family attorney serving as the trustee for the minor child of a deceased client.  If a balloon payment comes due on a commercial property owned by the irrevocable trust, the trustee certainly isn't going to be willing to guarantee some $800,000 new commercial loan.
Today I am announcing that Blackburne & Sons will make non-recourse commercial loans in any of the above situations.  That being said, like almost all portfolio commercial lenders who survived the Great Recession, Blackburne & Sons will continue to require a personal guarantee on almost all other commercial loans.

But here's a secret.  Shush.  If you happen to have a commercial loan that is waaaaay too good for Blackburne & Sons, and all it takes for us to land the deal is to be flexible about the personal guarantee, then ... shush ... we'll do it.
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Topics: Non-recourse

Commercial Loans and Burn-Off's

Posted by George Blackburne on Thu, Aug 14, 2014

RenovationI have been in the commercial loan business for over 34 years now, but I still learn more about commercial real estate finance ("CREF") almost every day.  This week I learned a new commercial loan term:


Suppose you have a property that is 50% occupied due to mismanagement from the previous owner.  The business plan is to increase the NOI significantly after adding upgrades and capital improvements.

A lender may want full recourse on the loan to start (so they know the Varsity is on the field).  Once a debt service coverage ratio (DSCR) of 1.20 is hit for three consecutive months, the recourse burns off.  This commercial loan is now a non-recourse loan.

My thanks go out to David Repka of Bison Financial Group for this clear explanation.  David is looking for commercial construction loans of over $10 million and can be reached at 
Commercial loan demand has been very weak for the past several weeks.  Fortunately, however, we are approaching Busy Season.  For guys in the commercial loan business, the three month stretch between September 10th and the end of November is historically a very busy time.  At least at Blackburne & Sons, we typically close 40% of our commercial loans for the entire year during this eleven-week period.
Hey, guys, now I need your help.  I want our hard money commercial mortgage company, Blackburne & Sons, to start making more commercial property renovation loans.  Unfortunately I have a documentation problem.

When a bank makes a ground-up commercial construction loan, it gets to see a detailed set of Plans and Specifications and a Construction Contract with the general contractor.

Unfortunately, for most small balance commercial renovation loans, there is no detailed set of plans and specifications.  To make matters murkier, the owner wants to act as his own general contractor because he intends to do much of the work himself.
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How can a small balance commercial construction lender like Blackburne & Sons make sure that its money is being properly spent on improving the property and that the owner-borrower is not over-spending the budget fixing unforeseen deficiencies that were discovered after the sheetrock came down?

Now I know all about construction control companies.  Using a construction control company does not solve my problem.  The problem is that there is seldom a detailed set of plans for the renovation work proposed.  To make matters worse, there is no contract with a general contractor to which my lending documents can refer.  Therefore the construction control company has nothing against which to gauge the project's progress.

For example, what exact work is to be performed in apartment number twenty-six?  What are the costs and the specifications of the materials to be used to renovate apartment number twenty-six?  Is there enough money remaining in the construction budget to renovate each apartment?

How on EARTH can I document the fact the owner-borrower-renovator has gone over budget?  How can I document that the renovator has used substandard materials or failed to complete all of the planned renovations in apartment twenty-six?  Remember, there is almost never a set of plans.

Now if this were a $10 million commercial construction loan, we could demand that the owner-borrower-renovator hire either an architect or an engineer to prepare a detailed set of plans.  But what if my commercial loan is only $600,000?  Economically such a requirement is infeasible.

Now Blackburne & Sons is fine making commercial property renovation loans when there is already a roof and four walls.  As long as the renovation component is less than 40% of the commercial loan proceeds, we're fine.  We make a ton of such commercial property renovation loans.
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Gosh darn it!  My commercial loan borrower needs $2.1 million, but the bank will only lend him $1.7 million.  Why did they cut the loan?  The property could easily carry $2.1 million.  Where on earth can I find someone to cover our $400,000 capital shortfall?
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Topics: Burn off