Underwriting is a critical component of the commercial real estate industry, but it can be challenging to understand just what it is. To begin building commercial property projects, builders need capital, and underwriting is one of their best options for raising that capital.
The underwriting process involves analyzing the client's financial, market and construction plans to determine if they are a reasonable risk and if they have a legitimate chance of meeting the necessary milestones outlined in the contract.
The Underwriting Process
Underwriting involves a few simple steps. To begin, the builder will obtain an estimate from a general contractor for the project's cost. The general contractor will then submit the estimate to both the lender and underwriter, who will review it to ensure it is feasible.
This step involves several components:
- Calculating an appropriate loan-to-value ratio LTV
- Estimating cash flow and determining if the results are positive or negative.
After the contractor has submitted the estimate to the underwriter, they will assess it to determine if the project is viable and give you a solid idea of your costs. From there, you and your general contractor will create an acceptable budget for your lender and the underwriter. They will narrow down that budget until you have sufficient documentation to be approved for funding.
How Commercial Loans Work
One significant difference between commercial and residential real estate loans is the fact that commercial loans must have a set amount of cash flow. It can be challenging to obtain in the early stages of the project, so it is essential to create a solid plan that includes how you will generate this cash flow in future years.
For example, you might plan on renting out spaces after the project is completed, or there may be plans for future developments that you could use to help pay off your loan.After the lender has approved your project, they will work with you to determine how much money you need to get started and how much of that money must be used for construction.
Once the builder receives their first check after becoming an underwriter, they will submit the funds to their lender and underwriter. If approved, you will receive your next shipment of cash from your lender once construction is complete.
How Underwriter and Lender are Connected
It is important to note that an underwriter is a title given to the person hired by a lender to assess the feasibility of a commercial project. The underwriter works alongside the lender's loan officer, and they are essentially two separate entities.
Typically, the lender will hire an underwriter who also services other lenders, allowing you to work with them directly instead of having multiple people on your side. Lenders will underwrite commercial loans to ensure that the project is feasible and that the contractor has a great chance of meeting its milestones.
There are many different reasons for this, but the most important is that a builder needs capital to start their first project, which can be challenging to obtain if they do not have a solid background. It is also critical that the builder use their money to make sure they can pay off their loan after construction is complete.
How Long Does The Process Take
The underwriting process can take anywhere from two months to six months, depending on how long it takes for the lender or underwriter to approve the appropriate documents. Once your project has been approved, and your lender has given you the green light, it is time to start building.
Are There Ways to Speed Things Up?
There are specific steps to speed up the process. For example, if you already have an account with a lender or underwriter, it can help to have them look at your proposal so that you don't have to create all your documents from scratch.
You should also be aware of reducing time spent on your project by using high-tech tools and materials, such as 3D rendering software.
Mistakes to Avoid
You want to avoid several mistakes if you hope to be approved for underwriting. The most important thing you can do is make sure that you have a solid plan and show that you will complete your project at the end of the construction process.
You may also want to consider hiring an outside firm as an independent contractor so that they can review your documents and turnaround time promptly.
What Happens if Your Project is Denied?
If your project is denied, there are several ways that you can handle the situation. You could work with the lender and underwriter to address the issues raised in their rejection letter, or you may need to start over and apply for underwriting with a different lender or underwriter.
Ultimately, you want to ensure that your project is feasible and that you use your money to pay off your loan after construction is complete.
The underwriting process's primary goal is to ensure that your project is feasible and that you have a solid plan for paying off your loan. Ultimately, you want to ensure that your project will be completed as soon as possible so that you receive full payment once construction is complete.