Hard Money Versus Business Entity Construction Loans

In commercial real estate, hard money loans and business entity construction loans both use the real estate being financed as collateral, but they solve different funding problems. Here’s a table quickly showing those differences:

What exactly is a business entity construction loan?

As you can tell from the name, business entity construction loans are made to entities — meaning LLCs, corporations, partnerships, or special-purpose entities created for the project. They are not intended for individual borrowers.

If you’ve formalized your CRE venture as an entity, you may use this type of loan for:

• ground-up construction
• major renovations
• redevelopment

Since the loan funds a project instead of just a purchase, the lender has to understand how the work will get done.

How is a business entity construction loan different from a hard money loan?

Traditional hard money loans usually focus on the property and the payoff timeline: the lender primarily asks (1) whether the property is worth enough to justify the loan amount and (2) whether you can repay the debt through a sale or refinance.

This structure works well for deals that are more straightforward, such as if you’re buying a property at a discount and plan to sell or refinance quickly.

But if you are funding a major construction project, it might not be the best loan structure. As you know, construction adds more risk because the property changes over time.

The project may be only raw land or a half-finished building at closing, so the lender cannot rely only on what the property is worth right now.

They need to estimate what the project might be worth after all the work is done and whether you can actually get there. Business entity construction loans are built around that added construction risk.

How did business entity construction loans become more common?

Traditional lenders tightened construction loan standards after the 2008 financial crisis, so developers with viable projects often had to deal with rigid income requirements and slow loan committee reviews that delayed projects.

Private lenders stepped in to fund projects that fell outside bank policy, but construction financing needed more structure than a simple bridge loan.

To protect their capital, they needed to build in construction oversight measures that allow them to:

• Release funds in stages
• review budgets
• confirm that work is actually progressing
• Protect the collateral as the project changes

Borrowers also changed. More CRE investors now buy and build through LLCs or project-specific entities, so the loan structure had to match the way professional developers already operate.

What do lenders evaluate when underwriting business entity construction loans?

To put it simply, the lender needs to know what the property is worth today and what it should realistically be worth after completion. From there, they review your:

• Construction budget – This tells the lender whether the loan amount you’re requesting matches the scope of work.
• Permits and approvals – Can the project progress without major delays? If you still don’t have the key permits in order, the loan will be riskier in the lenders’ eyes.
• Proposed draw schedule – This is where you indicate when you need the funds released and what work should be completed before each release. The lender will then review that schedule against the budget and construction/inspection timelines.
• Equity contribution – Tell the lender how much of your own money you’re planning to put into the project. Does the loan amount you’re requesting cover too much of the total project cost? The lender may ask you to either lower the request or increase your equity contribution.
• Payoff plan – Then the lender will analyze whether your projected sale price is defensible if you plan to sell. And if you plan to refinance, the lender will look at whether banks will realistically approve the completed project for permanent financing.

To know in-depth about all the aspects of Hard Money Loans, read our detailed guideline on Hard Money Qualification Requirements and Approval Process

Does your experience as a sponsor count?

Yes, even if the loan is being made to your LLC or corporation.

Construction loans depend on execution, after all, so the lender will want to know if you can:

• keep the work on budget
• handle contractor issues
• get through inspections
• repay the loan as planned

If you have completed similar projects before, the lender has more reason to believe that your plan is realistic.

Does the structure of the entity make a difference?

A business entity construction loan is made to the company that owns or will own the project, so before the lender can close, they need to confirm that:

• the entity exists
• the right people control it
• The signer has the authority to borrow

The lender may ask for:

• operating agreement
• a certificate of good standing
• ownership information
• borrowing authorization

The borrower’s name should match the purchase contract and title documents.

The operating agreement should also show who owns the entity and who can sign loan documents.

When will hard money be a better option than a business entity construction loan?

If your financing requirements are simple and short-term, a full construction loan structure may be too complicated and unnecessary.

Go with hard money if you only need temporary capital.

Are you planning to build through an LLC or corporation?

Private Capital Investors can help you evaluate what commercial property loan best suits your project. Submit your loan scenario here. You can also call us at 972-865-6205.