Construction financing is among the most complex transactions in commercial real estate. Unlike acquisition or stabilized refinance deals — where the asset exists and can be underwritten based on current performance — construction loans are underwritten against a pro forma, a set of plans, a budget, and a borrower's track record. The lender is essentially betting on something that does not yet exist. That complexity is why the documentation requirements are extensive, the underwriting is detailed, and the deals that make it to closing are the ones that were prepared correctly from the beginning.
The capital stack in construction
Before discussing the loan itself, it is worth understanding the full capital stack that lenders expect to see in a ground-up construction deal. The construction loan is typically the largest piece, but it does not stand alone.
Equity contribution
Construction lenders typically require the borrower to contribute equity representing 20% to 35% of the total project cost — not just the land, but the full construction budget. The equity must be in the form of cash or the documented value of land already owned free and clear, and lenders will require evidence that the equity is committed and available before they begin funding draws. In today's environment, with construction costs elevated and cap rates compressed, many lenders are requiring closer to the 30% to 35% range for speculative development.
The construction loan
Construction loans are typically interest-only during the construction period, with draws made in arrears based on verified completion of defined phases. The lender controls the draw process through a third-party inspector who visits the site before each draw is approved and confirms that the work claimed in the draw request has been completed and the materials are on-site. This inspection process is a safeguard for the lender, but it also means draws take time — typically 10 to 20 business days from request to funding — which creates cash flow considerations for the developer.
Mezzanine and preferred equity
For larger or more complex projects, mezzanine financing or preferred equity can fill gaps between the senior construction loan and the developer's equity. These instruments are more expensive than senior debt but less expensive than additional equity, and they allow developers to increase their leverage while maintaining the senior loan within the construction lender's LTC parameters. Not all construction lenders permit subordinate financing, so this is a structure that needs to be disclosed and negotiated upfront.
The projects that get funded are not necessarily the best projects. They are the projects that are presented to the right lenders, with the right documentation, at the right time.
What lenders require before they will commit
Full entitlements and permits
No institutional construction lender will commit to funding a project that does not have full entitlements in place. Entitlement risk — the risk that zoning approvals, variances, or permits will not be obtained — is not a risk that construction lenders take. Speculative entitlement financing is a separate product, typically funded by bridge or mezzanine lenders at higher cost, specifically to carry projects through the entitlement process. Once full building permits are issued, the project is ready for a construction loan.
Fixed-price construction contract
Lenders want to see a fixed-price or guaranteed maximum price (GMP) contract with a qualified general contractor. The contract is the document that gives the lender confidence in the construction budget — it tells them that the contractor has committed to deliver the project at a defined price, and that cost overruns (within defined parameters) are the contractor's responsibility rather than the developer's. A project with a cost-plus contract, where the ultimate construction cost is undefined, is a much harder financing story.
General contractor qualification
The general contractor's qualifications are underwritten almost as carefully as the borrower's. Lenders review the GC's financial statements, bonding capacity, insurance certificates, license status, and completed project history. A GC who has not delivered projects of similar size and complexity is a risk factor. A GC who has defaulted on projects or has outstanding liens is typically disqualifying.
Project budget with contingency
The construction budget needs to be detailed and supported — not a high-level estimate but a line-item budget developed by the contractor and reviewed by the lender's independent cost consultant. The budget must include a contingency reserve, typically 5% to 10% of hard construction costs, that provides a buffer against cost overruns. Lenders look carefully at the contingency — too thin, and they are skeptical the budget is realistic; absent entirely, and they may require a funded reserve.
Sponsor track record: the most underrated factor
Of all the factors in construction loan underwriting, sponsor track record may be the most important and the most underestimated by first-time or emerging developers. Lenders are not just underwriting the project — they are underwriting the person who will manage the project through 18 to 36 months of construction, subcontractor management, draw processes, cost overruns, weather delays, supply chain disruptions, and market changes.
A developer with a strong track record — completed projects of similar scale, in similar markets, on time and within budget — can access significantly better terms and a broader pool of construction lenders than a developer without that history. The terms are better because the risk premium is lower. The pool is broader because many lenders have minimum track record requirements that effectively exclude first-time developers.
For emerging developers, the practical implication is that the path to better financing runs through smaller projects first. A developer who has completed two successful townhome projects has a story to tell when approaching a construction lender for a 50-unit multifamily deal. A developer whose only track record is a single-family renovation does not.
The draw process: where many projects run into trouble
Even after a construction loan closes, the draw process creates ongoing operational challenges that borrowers frequently underestimate. Draws require submitting detailed pay applications, lien waivers from all subcontractors and material suppliers, the third-party inspector's report, and in some cases photographs and title updates confirming that no new liens have been filed against the property. This administrative burden is substantial, and mistakes in the draw package — missing lien waivers, incomplete pay applications, discrepancies between the inspector's report and the draw amount requested — cause delays that create cash flow pressure across the entire project.
The best developers treat the draw process as a parallel operational track, not an afterthought. They have administrative staff or a project manager specifically responsible for draw preparation, they communicate proactively with the lender about the draw timeline, and they factor realistic draw timing into their cash flow projections so that contractor payment schedules are aligned with expected draw funding.
CAPITICS has structured construction and development financing across residential, commercial, and mixed-use projects. If you are planning a ground-up development, talk to us early in the process — it makes a material difference in the outcome.