Construction Takeout Loans: How They Work and How to Apply

A commercial property construction site

What Is a Construction Takeout Loan?

The terminology sounds a bit intimidating, but a construction takeout loan is a pretty straightforward concept. It “takes out” your short-term, high-rate construction loan.

The short-term construction loan is a type of debt designed to pay the contractors while an office building, shopping center, warehouse or other commercial property is under construction. Construction loans have a limited time horizon — they cover costs from the planning phase to the development phase and through the completion of construction. When the construction crews leave and the project ends, the construction loan ends, too.

That’s where the construction takeout loan comes into play. A staple of commercial construction financing, the takeout is a permanent loan that pays off the balance of your short-term construction loan.

What’s the Difference Between a Construction Loan and a Takeout Loan?

The term — the length of time for the financing — is one big difference. A construction loan typically lasts 12 to 18 months. It’s meant to be interim financing, not a permanent loan or mortgage. The takeout loan, on the other hand, acts as a permanent mortgage. It’s a type of financing that’s designed to meet your capital needs for five to 10 years.

Rates are another distinction. Because a construction loan is backed by a work in progress, the rate tends to be high compared to a longer-term loan. Once construction is complete and lenders can underwrite an existing asset as collateral, the rates come down.

Sometimes it makes sense to use a commercial bridge loan as the takeout. For instance, if lease-up is taking longer than anticipated, or if a permanent loan isn’t available with the best terms, a bridge loan might provide the better option for interim financing.

3 Benefits of Takeout Loans

Takeout loans are common in commercial real estate for a number for at least three reasons:

1. The Takeout Loan Pays Down Your Construction Debt

By retiring your short-term construction loan, the takeout loan moves you from a higher-rate, shorter-term construction loan. The sooner you pay down the construction loan, the more costs you avoid, said Garrett Boorojian, managing partner at WaveCapital Partners.

2. The Takeout Loan Offers Long-Term Certainty

Construction is a nerve-racking process, one fraught with delays and unexpected issues. Once you lock in a takeout loan, you’ll have a greater degree of certainty around your business costs.

3. The Market for Takeout Loans is Robust

The coronavirus pandemic scared many lenders at first. However, with capital markets booming, lenders are getting aggressive. As of mid-2021, borrowers could expect to pay low rates and to find plenty of competition for their business.

“It’s an exciting time for borrowers,” said Charles Foschini, senior managing director at Berkadia, a commercial real estate services firm. “They’re getting rates they’ve never seen in their lifetimes.”

The Downsides of Construction Takeout Loans

While there are many upsides to takeout loans, there can be a couple of potential disadvantages, Boorojian said:

  1. The construction lender might want to seek a cut of the property’s rents.
  2. If the commercial property is sold, the takeout lender might insist on a cut of the capital gains.

Here’s What Your Commercial Mortgage Lender Will Need to Approve Your Construction Takeout Loan

Like many forms of financing, a takeout loan requires a ton of paperwork. Among the requirements:

Construction Receipts

The loan officer will dig into the details of your construction loan: scrutinizing the original plans, the draw schedule and invoices to be certain work was completed according to specifications.

A Certificate of Occupancy

To move from the construction phase to the operating stage, you and your contractors will need to jump through all sorts of hoops for inspectors. Until your building receives a certificate of occupancy, it’s not ready for a takeout loan.

A Lien Check

If you don’t pay your contractors, or if contractors dispute the amount you owe them, they can respond by filing liens. Your property will need to be free of construction liens before the construction lender closes the deal.

Other Standard Documentation

Your lender will want to see corporate tax returns going back three years, corporate bank statements for several months and any lease agreements involving the subject property. If there are personal guarantors to the takeout loan, they’ll need to supply personal tax returns and bank statements.

Construction Loan Takeouts Fuel Commercial Real Estate

Construction loan takeouts play a crucial role in commercial real estate: they let investors and developers take risk with the confidence that they’ll land new financing at a reasonable rate. Construction loan takeouts let commercial property owners pay off their construction loans and switch to a more affordable long-term mortgage. Without them, it’s likely we wouldn’t see nearly as many buildings go up in the first place.

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