Building or renovating a commercial property is one of the largest capital commitments a business owner makes. A commercial construction loan funds the project in stages, releasing money as the work gets done rather than handing you a lump sum on day one.
That staged structure protects both you and the lender, but it also makes construction loans more involved than a standard commercial real estate loan. There are inspections, draw schedules, interest reserves, and conversion timelines to manage. Miss one detail and your project stalls or your costs spike.
Here is how commercial construction loans work, what they cost, who qualifies, and how to keep the project on track financially from groundbreaking to certificate of occupancy.
How Commercial Construction Loans Work
A construction loan is a short term loan, typically 12 to 24 months, that funds the building or renovation of a commercial property. It works differently from a term loan or mortgage in three ways.
Staged disbursement. The lender does not hand you the full loan amount at closing. Instead, funds are released in draws tied to construction milestones. You submit a draw request, an inspector verifies the work, and the lender releases the funds. This protects the lender from funding a project that stalls halfway through, and it protects you from paying interest on money you have not used yet.
Interest-only payments during construction. During the build, you pay interest only on the amount disbursed. If your total loan is $1.5 million and only $400,000 has been drawn, you pay interest on $400,000. This keeps your carrying costs manageable while the property is not generating revenue.
Conversion or refinance at completion. Once construction is finished and the property has a certificate of occupancy, the construction loan either converts to a permanent mortgage (in a construction-to-permanent structure) or you refinance into a separate long term loan. If you do not have a takeout plan in place, the full balance comes due at maturity.
Types of Commercial Construction Loans
The right loan type depends on your project size, timeline, and whether you plan to occupy the building or lease it out.
SBA 504 Construction Loans
The SBA 504 program funds ground-up construction and major renovation for owner-occupied commercial properties. The structure splits the financing three ways: a bank provides 50% as a first mortgage, a Certified Development Company (CDC) provides up to 40% funded by an SBA-backed debenture, and the borrower contributes 10% equity. Rates on the CDC portion are fixed for 20 or 25 years based on Treasury rates. The bank portion can be fixed or variable.
The catch is the 51% owner-occupancy requirement. You must occupy at least 51% of the finished building for existing buildings and 60% for new construction. The application and approval process takes longer than conventional loans, typically 60 to 90 days. But for businesses that qualify, the low down payment and below-market fixed rates make the wait worth it.
Conventional Bank Construction Loans
Banks and credit unions offer construction loans with more flexibility than SBA programs but higher equity requirements. Expect 20% to 30% down, rates of 7% to 10%, and terms of 12 to 18 months for the construction phase. The best rates go to borrowers with 700+ credit scores, two or more years in business, and strong cash reserves.
Most bank construction loans are structured as construction-to-permanent, meaning the loan converts to a long term mortgage once the project is complete. This saves you the cost and hassle of closing on a separate refinance. The permanent rate locks in at conversion, so keep an eye on rate movement during the build.
Hard Money Construction Loans
Hard money lenders fund construction projects based primarily on the property's after-completion value rather than the borrower's credit. Rates run 12% to 18% with 2 to 4 points in origination fees. Terms are short, typically 12 to 18 months.
Hard money makes sense in two situations: when your credit or financials do not qualify for bank financing, or when you need to close faster than a bank can move. Some developers use hard money to start the project, then refinance into a bank loan once the building is partially complete and the risk profile improves.
What It Costs
Construction loan costs go beyond the interest rate. Here is what to budget for.
| Cost Component | SBA 504 | Bank Conventional | Hard Money |
|---|---|---|---|
| Interest rate | 6.5% to 8.5% | 7% to 10% | 12% to 18% |
| Origination fee | 0.5% to 1.5% | 0.5% to 1% | 2 to 4 points |
| Down payment | 10% | 20% to 30% | 20% to 40% |
| Construction term | 12 to 24 months | 12 to 18 months | 12 to 18 months |
| Inspection fees | $300 to $500 per draw | $300 to $500 per draw | $300 to $500 per draw |
Beyond these line items, budget for architectural plans, engineering reports, environmental assessments, permits, and a contingency reserve of 5% to 10% of the total project cost. Lenders will require the contingency reserve before approving the loan. Projects that go over budget without reserves in place risk a stop-work situation where neither the lender nor the borrower can fund the overrun.
Who Qualifies
Construction loan underwriting is tighter than standard commercial mortgages because the collateral does not exist yet. The lender is betting on a future building, so they scrutinize both you and the project.
Personal credit. 680 or higher for SBA and bank loans. Hard money lenders may accept 600, but your rate reflects the risk. If your credit is below the threshold, a bad credit business loan guide covers your alternatives.
Business financials. At least two years in business with financials that show you can carry the permanent debt once construction is done. Lenders model the debt service coverage ratio (DSCR) based on your projected income from the completed property. They want a DSCR of 1.2x or higher, meaning the property generates 20% more income than the debt payment requires.
Project documentation. Complete architectural plans, a detailed budget from a licensed general contractor, a construction timeline, and permits or proof of permit application. Lenders will also want an appraisal based on the projected completed value of the property, called an as-completed appraisal.
Contractor qualifications. The lender will vet your general contractor. They want a licensed, insured contractor with a track record of completing similar projects on time and on budget. If your contractor has a history of liens, delays, or abandoned projects, the lender will require a different contractor.
Cash reserves. Beyond the down payment, lenders want to see liquid reserves to cover cost overruns and interest payments during the build. How much varies, but 6 to 12 months of projected debt service is common.
Industries That Use Construction Loans Most
Commercial construction loans fund projects across almost every industry, but some sectors use them far more than others.
Medical and dental practices. Medical practices and dental offices frequently build custom facilities with specialized plumbing, HVAC, imaging infrastructure, and patient flow layouts that cannot be replicated in standard office space. A ground-up medical office can cost $250 to $500 per square foot depending on the specialty.
Restaurants and food service. Restaurants and bars and breweries use construction loans for new builds and for extensive tenant improvement buildouts. Kitchen ventilation, grease traps, walk-in coolers, and commercial-grade electrical systems make restaurant buildouts more expensive per square foot than general retail.
Contractors building their own facilities. Contractors and construction companies that have outgrown rented yard space build their own offices, shops, and storage facilities. They have an advantage in the application process because they can general-contract their own build, reducing costs and giving the lender confidence in project execution.
Auto repair and service businesses. Auto repair shops and collision centers need bay doors, lifts, paint booths, and specialized ventilation. Finding an existing building with that infrastructure is difficult, so many owners build from the ground up.
Warehousing and logistics. Logistics companies and wholesale distributors build distribution centers, cold storage facilities, and fulfillment warehouses sized to their operations. The per-square-foot cost is lower than office or medical space, but the total project size is often larger.
The Draw Schedule: How Funds Are Released
The draw schedule is the defining feature of a construction loan. Understanding it prevents cash flow bottlenecks that delay your project.
A typical commercial construction project has five to eight draws. Each draw corresponds to a construction milestone, and funds are released only after an inspector confirms the milestone is complete. Here is what a standard draw schedule looks like for a ground-up commercial build.
| Draw | Milestone | Typical % of Loan |
|---|---|---|
| 1 | Site preparation and foundation | 15% to 20% |
| 2 | Framing and structural | 20% to 25% |
| 3 | Mechanical, electrical, plumbing | 15% to 20% |
| 4 | Exterior close-in (roof, windows, siding) | 10% to 15% |
| 5 | Interior finish (drywall, flooring, fixtures) | 15% to 20% |
| 6 | Final completion and punchlist | 5% to 10% |
Lenders typically hold back 5% to 10% of each draw as retainage until the project passes final inspection. This gives them leverage to ensure the last details get finished. Plan your contractor payment schedule around the draw timing so your GC is not waiting weeks for payment after completing a phase.
Common Mistakes That Kill Construction Projects
Most construction loan problems are predictable. Avoid these and your project has a much higher chance of finishing on time and on budget.
Underestimating the budget. The number one reason construction loans go sideways is a budget that does not account for reality. Material prices shift. Permitting takes longer than expected. Soil conditions require unplanned foundation work. Build a 10% contingency into your budget before you apply. If the project comes in under budget, you return the unused funds. If it does not, you have a cushion.
No takeout commitment. A construction loan matures in 12 to 24 months. If you do not have a permanent financing commitment or a construction-to-permanent loan, you are betting that you can refinance under whatever conditions exist when the build finishes. If rates rise or your project hits a snag, refinancing may not work on the terms you expected. Lock in your permanent financing before you start.
Skipping the interest reserve. During construction, you owe interest on disbursed funds but the building generates no revenue. Some borrowers fund these payments from operating cash flow. Others build an interest reserve into the loan, where the lender sets aside enough to cover interest payments for the full construction term. Skipping the interest reserve and then hitting a slow month in your existing business creates a situation where you cannot service the construction loan.
Choosing the wrong contractor. Your lender will vet your GC, but you need to do your own due diligence. Get references from completed projects of similar size and scope. Verify their license, insurance, and bonding. Check for liens and complaints. A contractor who underbids to win the project and then hits you with change orders throughout the build will blow your budget and strain your lender relationship.
Ignoring the timeline. Construction delays cost money. Every month the project runs over schedule is another month of interest payments, another month without revenue from the property, and another month closer to loan maturity. Build realistic timelines with your contractor, include weather delays and permitting buffers, and manage the project actively.
How to Apply
Construction loan applications require more documentation than a standard business loan. Get these ready before you approach a lender.
Project package. Complete architectural plans, a detailed line-item budget from your general contractor, a construction timeline with milestones, and proof of permits or permit applications. Some lenders also want a Phase I environmental assessment for the site.
Business financials. Two to three years of business tax returns, a current profit and loss statement, a balance sheet, and a debt schedule listing all existing obligations. If you are building a new facility for your existing business, the lender will model whether your current cash flow can support the permanent debt.
Personal financials. Personal tax returns for all owners with 20% or more equity, a personal financial statement, and a credit report authorization. Most construction loans require a personal guarantee.
Contractor documentation. Your GC's license, insurance certificates, bonding capacity, and a portfolio of completed projects. The lender may also want a credit check on the contractor.
Start with your existing bank. If you have a business banking relationship and they do construction lending, they already know your financials and can move faster. If your bank does not do construction loans, approach community banks and credit unions that specialize in commercial real estate in your area. For SBA 504 construction loans, find a Certified Development Company in your region.
Construction Loan vs. Other Financing Options
A construction loan is not always the only path. Depending on your project, one of these alternatives may work better.
Commercial mortgage with renovation budget. If your project is a renovation rather than a ground-up build, some lenders will structure a commercial real estate loan with a renovation holdback. You close on the purchase and the lender holds back a portion of the loan for renovations, released on a draw schedule. This works for projects under $500,000 in renovation costs.
SBA 7(a) for smaller projects. SBA 7(a) loans can fund construction up to $5 million, though the 504 program is better suited for larger projects. The 7(a) is more flexible on property type and occupancy requirements.
Bridge loan plus permanent financing. A bridge loan can fund a quick-turnaround renovation if you need to get into the space fast and refinance later. This works for projects with a 3 to 6 month timeline where a full construction loan process would take too long.
Equipment financing for buildout components. If your construction project includes expensive specialized equipment like a commercial kitchen, manufacturing line, or medical imaging suite, financing the equipment separately through an equipment loan can reduce the construction loan amount and simplify the draw schedule.
Frequently Asked Questions
What is a commercial construction loan?
A commercial construction loan provides short term funding to build, renovate, or expand a commercial property. Unlike a standard commercial mortgage that pays for an existing building, a construction loan disburses funds in stages as the project hits milestones. The lender inspects progress before releasing each draw. Once construction is complete, you either refinance into a permanent mortgage or the loan converts automatically if you have a construction-to-permanent structure. Loan terms during the construction phase typically run 12 to 24 months.
How much down payment do I need for a construction loan?
Most commercial construction loans require 10% to 30% of the total project cost as a down payment or equity injection. SBA 504 construction loans require as little as 10% from the borrower. Conventional bank construction loans typically want 20% to 25%. The exact requirement depends on the project type, your credit profile, time in business, and whether you already own the land. Land you already own can often count toward the equity requirement.
What credit score do I need for a commercial construction loan?
Bank construction loans generally require a personal credit score of 680 or higher. SBA construction loans typically want 680 as well, though some lenders will consider 660 with strong compensating factors like significant cash reserves or a long track record in the same industry. Alternative lenders and hard money construction lenders may work with scores as low as 600, but the interest rates will be significantly higher, often 12% to 18% compared to 7% to 10% for bank products.
How does the draw schedule work on a construction loan?
A draw schedule is a series of predetermined milestones tied to construction progress. Common milestones include site preparation, foundation, framing, mechanical systems, interior finish, and final completion. Before each draw, the lender sends an inspector to verify that the work has been completed to spec. Once the inspection passes, the lender releases the next tranche of funds. You only pay interest on the amount that has been disbursed, not the full loan amount. Most construction loans have five to eight draws over the project timeline.
Can I get a construction loan for renovation or buildout?
Yes. Construction loans are not limited to ground-up builds. Many lenders offer renovation construction loans for major buildouts, tenant improvements, and property repositioning. SBA 504 loans can fund renovation projects as long as the property is at least 51% owner occupied. The process is similar to new construction. You submit plans and a budget, the lender appraises the property based on its after-renovation value, and funds are disbursed on a draw schedule as work is completed. Renovation loans are common for restaurant buildouts, medical office conversions, and warehouse expansions.