If you’re planning to develop a new apartment building or complex, a new construction apartment loan can help you access the funds you need to get your project off the ground. There are several traditional options when it comes to getting a loan for apartment construction—as well as several alternatives that may be suitable for some developments. Read on to better understand how multifamily construction loans work and how to apply.
What is a New Construction Loan
A new construction loan is a type of financing that can be used to finance the development of a new home. New construction loans can be either conventional or FHA loans, and they can either be for a single-family home or a multi-family unit. New construction loans are often interest-only during the draw period, and can be either fixed-rate or adjustable-rate mortgages (ARMs).
The biggest difference between a new construction loan and a regular mortgage is that with a new construction loan, the borrower is not actually borrowing money to purchase an existing home. Instead, the borrower uses the loan to finance the construction of a new home, and receives funds in several disbursements throughout the draw period. This means that there is additional paperwork involved in processing a new construction loan, as compared to a regular mortgage.
How Loans for Apartment Construction Work
With traditional real estate loans, borrowers make a down payment on a property and then pledge that real estate as collateral for the mortgage. When taking out a construction loan, however, the lender’s initial collateral is the land that’s being developed (or the land lease, in certain major markets). Once a loan is approved, the borrower enters the draw period, during which loan funds are released as the apartment (the lender’s collateral) reaches certain construction milestones.
Here’s how loans for apartment construction work:
- Buy the land in cash. Before starting construction, purchase the land you intend to develop. In most cases, you’ll need to pay for the land in cash. However, if you don’t have sufficient funds, you can finance the purchase with a land loan.
- Prepare a pro forma. Next, you’ll need to prepare financial projections that outline the proposed construction project. This document should also include information like the type of apartment to be built, number of units, estimated construction costs, expected completion date, and anticipated value of the completed project.
- Apply and pledge land for the loan. Once you prepare the pro forma, start working with a lender and pledge the land as collateral for the loan. This means that if you default on the loan, the lender can seize the land.
- Get approved. After applying for a loan, await an approval decision. This process can take a little longer than conventional loans, because they rely on uncertain financial projects and represent additional risk for lenders. Depending on your lender and the size of your project, the approval process can take several weeks or even months.
- Enter the draw period. When the loan is finalized, you’ll enter the draw period, during which the lender will begin to release funds as you begin construction of the apartments. The amount of each draw and the frequency of draws will be determined by the lender. Funds are often released directly to construction vendors after invoices are reviewed by the lender.
- Start construction. Once you secure financing for the construction project, you can begin construction. Construction typically takes anywhere from six months to one year to complete. As construction progresses, periodically submit invoices from vendors to your lender, and they will release loan funds to pay contractors and material suppliers.
- Make interest-only payments. New construction loans typically have an interest-only period. This means that during the first few years of the loan, you’re only required to make interest payments and won’t be required to make any principal payments during this time.
- Convert to an amortized loan. After construction is complete and all of your vendors have been paid, work with your lender to convert your construction loan to a long-term fixed- or adjustable-rate loan that includes regular monthly payments of both principal and interest. Many new construction loans typically have a conversion option, which allows you to convert the loan to an amortized loan fairly easily.
- Enter the payback period. Once you convert your construction loan to an amortized loan, you enter the payback period. The payback period is the length of time over which you repay the loan. Most new construction loans have terms that last from 15 to 30 years.
- Make your payments. During the payback period, make regular principal and interest payments. New construction loans are typically made with monthly payments, but some lenders may require bi-weekly or weekly payments. If you sell units during the payback period, you may be required to pay down a portion of the loan balance with each sale. You’ll also need to pay any real estate taxes and maintain adequate insurance coverage as you repay your loan.
Types of Multifamily Construction Loans
If you want to develop an apartment or condo complex, there are several types of loans that can help finance your project. While conventional loans may work for some small developments, others may be appropriate for government-backed financing (such as affordable housing projects)—while others may require a hard money loan for fast closing.
| Loan Type | Use Case |
| Conventional | Four-unit complexes or fewer; one is owner-occupied |
| Government-backed | Good-credit borrowers with a history of developing apartments and condos |
| Hard money | Lower-credit borrowers or those who need to sell an older project before refinancing with better terms |
These are some of the main types of construction loans:
Conventional
Using conventional financing for apartment construction is a great way to get your project off the ground. Conventional loans are those that are issued by lenders and later securitized through Fannie Mae or Freddie Mac (when they’re converted to amortized loans). This includes both fixed-rate and adjustable-rate mortgages.
The key thing to remember about using conventional financing for apartment construction is that you must have a solid business plan and be able to demonstrate that your project will be profitable. Lenders want to know that you’re not taking on too much risk, so they’ll scrutinize your numbers closely. But if you can pass muster, getting a loan should be a relatively straightforward process.
Government-backed
US Department of Housing and Urban Development (HUD)/Federal Housing Administration (FHA)-backed loans are a popular choice for apartment construction. There are many different types of government-backed loans, but all of them have one thing in common: they’re designed to help developers build affordable housing.
Plus, HUD/FHA-backed loans offer lower interest rates and longer terms than available with conventional loans. These features make HUD/FHA-backed loans the perfect choice for projects with a low profit margin or for developers who need help getting their project off the ground.
That said, there are a few things to keep in mind if you’re considering a HUD/FHA-backed loan. For one, you’ll need to have a good credit score in order to qualify. Plus, HUD/FHA loans are only available for projects that fall under certain income limits. So if your project doesn’t meet those criteria, you’ll need to look into other financing options.
Hard Money Loans
Hard money loans are typically used by real estate investors who want to get a project started quickly. Lending standards are not as rigorous as for other types of financing, and there is less concern about the credit history or financial stability of the borrower. Underwriting for hard money loans is usually less time-intensive than conventional loans, and hard money financing also tends to be shorter in terms of repayment, typically one to three years.
One downside of hard money loans, however, is that they can be more expensive than other types of loans. Lenders may require outside collateral to secure a loan (in addition to the land being developed), and they may also require that the borrower have experience in real estate development.
New Construction Loan Alternatives
If traditional new construction loans aren’t a good fit for your next apartment development, consider an alternative source of financing. Bridge loans may be appropriate if you’re comfortable with shorter repayment terms, while a line of credit or rehab loan may be a better fit for certain projects. These are some of the most popular alternatives to standard multifamily construction loans:
- Bridge loan. Multifamily bridge loans are usually used as a stopgap to acquire raw land or get a project started before getting approved for conventional financing. They can also be used to finish construction if a builder runs out of financing before a project is complete. These loans have shorter repayment terms than other types of financing—typically one to two years. Bridge loans can be difficult to qualify for, and lenders often require borrowers to have prior experience in real estate development.
- Line of credit. Lines of credit are typically used by borrowers who have some equity in property and need additional financing to get the project started. Lines of credit can be ideal because they’re often revolving credit lines, which can be tapped repeatedly if you’re developing multiple properties at the same time. Repayment terms for lines of credit are usually one to two years.
- Rehab loan. A rehabilitation loan—or rehab loan—is a type of mortgage that is used to finance the renovation or rehabilitation of an existing apartment building or individual unit. The loan can be used for any repairs or renovations that are necessary in order to bring the property up to code or improve its appearance and marketability.
