by Sarah Lewis Belcher, Esq.
So, you have a great new project you want to start building ASAP to enable you to get in the ground and/or have the shell(s) up before the weather turns and/or to meet your completion schedule?
If you need a construction loan to finance the project, knowing the financing process can help expedite closing and your ability to get started.
The earlier you involve your lender the better. In addition to the usual underwriting review, the lender and its construction consultant will need a number of items concerning the project. Having a package of these materials ready can help speed the review and, therefore, the closing.
The construction documents that often must be provided include: plans and specifications, detailed construction budget, construction schedule, fixed price/guaranteed maximum price contract with the general contractor (GC)/construction manager (CM), architect/engineer’s contracts, municipal approvals including building permits, payment and performance bonds, builder’s risk insurance and consents to contract assignments from the GC, CM, architect and/or engineer.
These items will be reviewed by the lender and its construction consultant to confirm the project described in the plans and specs may be completed for the amounts in the budget and within the time frame in the schedule.
The construction loan process in New York state requires the preparation and filing of a building loan contract/construction loan agreement. If a lender doesn’t file such a document with the clerk of the county in which the real estate is located, the lender’s security interest established by its mortgage will be subject to mechanics liens that may be subsequently filed.
The building loan contract will specify the requirements for closing on the construction loan as well as obtaining advances after closing. The construction loan agreement is filed and is a matter of public record, so parties may prefer that it not contain certain details of the transaction that are often included in a loan agreement, such as the interest rate, payment provisions, financial reporting requirements and/or financial covenants.
If the borrower prefers that these types of provisions not be referenced in the construction loan agreement, borrower’s counsel should alert lender’s counsel early, preferably before document drafting commences.
To file a building loan contract, a Section 22 affidavit must be attached. This affidavit itemizes the expenses paid from the loan and the net amount available for the improvements. It contains figures from the final budget and closing statement and should be drafted earlier rather than later in preparation for closing.
One nuance that can impact the documents for a construction loan in New York is that a building loan may only be used to pay costs of improvement. A construction loan may not be used to pay acquisition costs or items that are not “costs of improvement.”
New York’s Lien Law specifies the types of expenses that qualify as a cost of improvement. These include contractor’s/architect’s/engineer’s fees, interest on and certain costs of obtaining construction financing, costs to take prior mortgages by assignment and taxes accruing before and after closing.
Any acquisition costs or other items to be paid from the loan that do not qualify as costs of improvement (such as borrower’s attorney’s fees, marketing expenses, developer overhead and leasing/broker fees other than for commercial leases with terms of more than 3 years) should not be included in the amount of or be paid from the construction loan to be sure the lender’s mortgage maintains priority over mechanics liens. The lender’s and borrower’s attorneys will work together to properly document the construction loan, but it can take time.
A borrower’s equity is generally required to be invested before building loan proceeds are advanced. This can enable a borrower to start construction before closing on the financing and avoid any delays associated therewith. Of course, borrower should first be confident the financing will come through before starting construction.
The lender will need adequate proof that borrower has contributed its equity amount, so borrower must keep detailed records of all its expenditures in that regard. Lenders may count the amount by which the land’s appraised value exceeds borrower’s acquisition cost toward equity, so this should be explored with the lender at the outset since it could make a difference for the borrower’s out of pocket costs.
Belcher is a senior counsel with Bond, Schoeneck & King PLLC and assists lenders, nonprofits, developers and businesses on a range of commercial financing and real estate matters.