A developer in Phoenix is building a 12-unit flex industrial complex. The kind of project where every bay is 2,500 square feet — perfect for contractors, distributors, e-commerce fulfillment — including a manufacturing facility tenant who signed a 5-year lease before the foundation was poured. Pre-leased 8 of the 12 units before breaking ground.
Total project cost: $4.2M. Land: $800K. Hard construction: $2.8M. Soft costs (architecture, engineering, permits, impact fees, legal): $600K.
Capital stack: construction loan at $3.4M covering 80% of total cost. Developer equity: $800K. Interest reserve of $215K built into the loan so he's not making payments during construction.
Here's where it gets interesting. Upon completion and stabilization, he refinances into permanent takeout financing at $3.8M — 75% of the stabilized appraised value of $5.1M. That $3.8M pays off the $3.4M construction loan and puts $400K back in his pocket. He recovers half his equity at refinance.
Build at cost. Refinance at value. That's the construction play.
total project cost on a 12-unit flex industrial — land, hard construction, soft costs combined
— Calculated — $800K land + $2.8M hard construction + $600K soft costs from intro example
How Construction Financing Actually Works
Construction loans aren't like regular commercial mortgages. You don't get a lump sum at closing. The money comes in draws — installments released as you hit construction milestones.
Here's a typical draw schedule:
- Closing/land: 15% of loan funds released
- Foundation complete: 15%
- Framing/shell: 20%
- Mechanical/electrical/plumbing: 20%
- Interior finish: 15%
- Final completion/CO: 15%
A third-party inspector verifies each milestone before the lender releases funds. This protects both you and the lender — money only flows when work is actually done.
During construction, you're paying interest only on the amount drawn. Month one, you've drawn $510K — interest on $510K. Month six, you've drawn $2.4M — interest on $2.4M. That's why construction loans include an interest reserve: a portion of the loan set aside to cover interest payments during the build so you're not writing checks out of pocket every month.
Bottom line:
Construction money flows in milestones, not lump sums — and the interest reserve keeps you from writing payment checks while the building isn't earning yet.
Construction Loan Costs by Project Type
These are real ranges through our commercial financing network:
| Project Type | Total Cost | Construction Loan (80% LTC) | Rate | Term | Interest Reserve | Permanent Takeout |
|---|---|---|---|---|---|---|
| 12-unit flex industrial | $4.2M | $3.4M | 8.5% | 18 mo | $215K | $3.8M at 6.5% |
| 30-unit multifamily | $8M | $6.4M | 8% | 24 mo | $512K | $7.2M at 6% |
| Retail strip center | $2.5M | $2M | 9% | 12 mo | $135K | $2.2M at 7% |
| Medical office building | $3.5M | $2.8M | 8.5% | 18 mo | $178K | $3.1M at 6.5% |
Notice the rates. Construction loans run 8-9% right now — higher than permanent financing because the lender is taking construction risk. The building doesn't exist yet. There's no completed asset to foreclose on if things go wrong. That risk premium is why permanent takeout financing at 6-7% matters so much. The hottest markets for ground-up deals right now are Texas commercial construction and Florida development projects — both states have population growth driving demand for every project type on this list.
Bottom line:
Construction rates carry a risk premium because the asset doesn't exist yet — that's why locking your permanent takeout up front is the whole game.
The Construction-to-Permanent Strategy
This is where developers make their money.
You build at cost — your total investment is $4.2M. But the completed, stabilized property appraises at $5.1M because the market values income-producing assets based on NOI, not construction cost.
When you refinance at 75% of that $5.1M appraised value, you get $3.8M. Your construction loan was $3.4M. The difference — $400K — comes back to you as cash. You've recovered half your original $800K equity investment.
Now you own a $5.1M asset with $1.3M in equity, you're holding $400K in cash, and the property is generating monthly income. Your effective out-of-pocket is $400K for a $5.1M commercial real estate asset.
That's why developers build instead of buy. The spread between cost and value is your profit — created through the construction process itself. Some developers use business acquisition financing to purchase the land or an existing property to redevelop, then layer construction financing on top — stacking capital sources to maximize leverage.
Bottom line:
Construction-to-permanent isn't just financing — it's how developers manufacture equity. Build at $4.2M, refinance at $5.1M, recover half your cash, keep the asset.
The math behind that equity creation is a function of how income-producing real estate gets valued at stabilization. Cost-to-build sets the floor; the income approach to value sets the ceiling. The spread between those two numbers is what shows up at refinance — and it's the entire reason developers build instead of buying finished product.
That structural arbitrage is also why having the takeout committed before the first draw matters so much. Without it, the construction lender carries the risk that your stabilized appraisal misses, and they price that risk into the construction rate.
Why Build Instead of Buy
Buying a finished asset means paying market price plus the original developer's profit margin. Building means you capture that spread — but only if you've got the financing structured right and the takeout committed before the first draw.
Structure your construction financing.
See What You Qualify For →Environmental and Permitting: What Lenders Require
Before any construction lender releases a dollar, they need:
- Phase I Environmental Site Assessment: $3K-$5K. Non-negotiable. If Phase I flags potential contamination, you'll need a Phase II ($10K-$30K) with soil and groundwater testing.
- Entitlements and zoning confirmation: Proof that your project is approved for the intended use. Lenders won't fund a construction loan on a property still fighting for rezoning.
- Full plans and engineering: Stamped architectural and structural plans. MEP (mechanical, electrical, plumbing) engineering. Site plan with grading and drainage.
- Permits: Building permit in hand, or at minimum a clear path to permit with documented timeline.
- Soil/geotechnical report: Confirms the ground can support the structure. Surprises here — expansive soils, high water table, rock — add cost fast.
- GC contract: Lender reviews your general contractor agreement, including fixed-price or GMP (guaranteed maximum price) terms.
Don't start the lending process until you have these in progress. A construction lender who sees a complete package moves fast. A lender who sees missing pieces slows everything down.
Why Lenders Front-Load the Diligence
Once construction starts, surprises cost real money — change orders, permit delays, expanded scope. Lenders push every diligence item to the front because that's where it's still cheap to fix. A clean Phase I beats a $30K Phase II mid-build every time.
The Nashville multifamily file is a clean example of what happens when the front-loaded diligence is actually done — Phase I, geotech, entitlements, GC contract all in hand at submission. The construction loan and permanent takeout closed concurrently, and the developer recovered seven figures of equity at refinance.
The closed structure below shows the construction-to-permanent stack, the timing of the refinance, and the equity recovery that made the project pencil — useful as a template for any 30+ unit ground-up project.
Nashville multifamily developer, 30-unit garden apartment
Construction-to-Permanent
$7.2M
Closed an $8M total project with $6.4M construction loan plus committed $7.2M permanent takeout up front; refinanced at completion to recover $1.1M in equity from the appraised value lift.
See the full case →Here's What Most People Get Wrong
They underestimate soft costs.
Every first-time developer I talk to has a hard construction budget dialed in — they know the per-square-foot build cost, they've got GC bids, they've priced materials. Good.
But soft costs catch them. Architecture: $150K. Structural engineering: $40K. Civil engineering and site plan: $60K. Permits and impact fees: $80K. Legal (entity formation, loan docs, tenant leases): $50K. Surveying: $15K. Environmental: $5K. Construction management: $100K. Insurance during construction: $30K.
That's $530K before you pour a single yard of concrete. On a $4.2M project, soft costs are 14% of total. On complex projects — medical office, mixed-use — they can hit 20%.
Budget 15-20% of total project cost for soft costs. If you come in under, great. If you budgeted 8% because you only counted the architect, you're going back to your lender mid-project asking for more money. That's a conversation nobody wants to have.
real soft-cost ratio on a complete project — most first-time developers budget 8%
— Calculated — industry observed soft-cost share versus typical first-developer pro forma assumption
Bobby's Take
Construction financing is the most complex financing type we structure. Multiple moving pieces, multiple lenders, timing dependencies between construction draws and permanent takeout commitments.
But it's also where capital stacking makes the biggest difference. A construction lender handles the build. A permanent lender commits to the takeout before you break ground. An equipment lender funds the FF&E (furniture, fixtures, and equipment). Purchase order financing for materials can cover large bulk orders during the build phase. All structured upfront so you know your total cost before the first shovel hits dirt.
The developers who do this well have their permanent takeout committed before construction starts. That's the move. You lock in your exit before you begin. The construction lender loves it because they know they're getting paid off. The permanent lender loves it because they're getting a brand-new asset. And you sleep better knowing the whole thing is structured from day one.
If you're planning a ground-up project, don't start with a GC bid. Start with a commercial funding calculator run. Know your total capital cost — including soft costs and interest reserve — before you commit to anything.
Frequently Asked Questions
What's the minimum down payment for a construction loan?
Most construction lenders require 15-20% of total project cost as developer equity. SBA 504 can reduce this to 10% for owner-occupied projects. Your equity can be cash, owned land (at appraised value), or a combination. Some lenders accept mezzanine financing as part of the equity stack.
How long does a construction loan last?
Construction loan terms match your build timeline — typically 12-24 months with extension options. Most lenders offer one or two 6-month extensions for a fee (usually 0.5-1% of the loan amount). Plan for 18 months minimum, even if your contractor promises 12.
What happens if construction costs exceed the budget?
You cover the overage from equity. Construction lenders don't increase the loan mid-project except in rare circumstances. That's why a 10-15% contingency budget is critical. If costs overrun beyond your contingency, you'll need additional equity or a supplemental loan — neither of which is easy to arrange mid-construction.
