What to Expect for Construction Loans in the Post-COVID-19 World?
Construction loans weren’t the easiest type of financing to secure even before the COVID-19 pandemic crisis of 2020. Unfortunately, the situation has only grown worse since then. The construction sector was one of the most affected by the crisis. According to PWC Research data, the financial impact on the industry is the greatest concern today. Furthermore, resolving issues around construction finance is currently a priority for many governments worldwide as it’s the only way to prevent the industry from a major collapse.
What Are Construction Loans and How Do They Work?
As the name indicates, construction loans are a type of financing specifically designed for construction projects. As businesses that operate these projects usually get payments only once they are complete, they need a way to finance the building process. This is when construction finance comes into play.
The amount of financing you can obtain through these loans depends on the projected value of the developed property. Therefore, there will be specific limitations to what you can apply for. Moreover, construction loans are short or mid-term in length. In the majority of cases, they are given for one year only.
Also, some loans are released in stages. Those finance every major construction step, such as foundation or structure framing completion.
Construction finance is secure by default because the property you are developing is used as security. Therefore, you shouldn’t need any additional security when applying. This is a benefit because it increases your chances of approval. However, the construction business’ credit rating and various external factors that will affect the developed property also have a big impact.
Due to the fact that these loans are very versatile, you will need to use a good construction loans guide when searching for this type of financing. You’ll need to compare the loan terms and conditions first of all. Many of the loans are straightforward but some will have terms like penalties for early repayment, etc. You should be very careful and study the offer thoroughly before applying for any kind of construction finance.
Why Are Construction Loans So Hard to Get Now?
The COVID-19 pandemic affected the world greatly and full recovery will take a long time. Due to the recession it caused, interest rates are now extremely low. However, not many developers can benefit from this because securing a loan is almost impossible.
The main issues are caused by high risks for financing providers. Construction loans are secure, which should lower the risk to an acceptable level. However, lockdowns, which are still happening, hinder construction businesses greatly. Due to unprecedented delays they are getting deeper and deeper into debt. This ruins the business’ credit rating and makes securing any kind of loan harder.
One also needs to understand that in these circumstances even promising commercial property development projects are at risk. Real estate markets in many countries are booming, but there are many concerns from investors that this is but a temporary bubble. With investors wary, independent construction finance is almost non-existent.
Meanwhile, traditional banks and credit unions cut down on loan origination for all financing. Construction loans might have slightly better approval chances due to their inherent security. But even they are rare as banks protect their remaining finds for liquidity.
The alternative construction finance industry is doing only marginally better. This is because alternative financing has higher risks by default. Therefore, many providers were deeply affected by the crisis and some even went bankrupt. The majority of these providers are startups that have a very limited capital. Without a constant stream of new loans they don’t have the funds to offer construction finance. Therefore, these companies are desperately looking for partners to fund them while the worst of the crisis passes. Some succeed, but their number is small.
Overall, it’s not only construction loans that are rare now. Obtaining any loan is difficult during an economic recession. There is no easy solution for this, even with government support and financing programs. These programs only have a limited budget and have stringent approval requirements.
All things considered, SME developers are now in a bind. Their debt is growing fast and with no construction finance available they might go out of business. This means that their development projects will have to stop, unless until a new owner with funds can complete them. As the times are uncertain and volatile, one can only wonder when this will happen. This situation contributes to the volatility of the construction sector, which only increases financing risks.
What’s in the Future for Those Who Require Construction Finance?
The current global economic crisis is worse than anything that happened since World War 2, according to the World Bank. However, shockingly the real estate market is booming instead of crashing. This means that for all that the construction sector suffered during lockdowns, it’s recovering and growing fast. In fact, the increase in demand is already outgrowing supply, so the need for construction loans will also keep increasing.
However, traditional banks aren’t likely to release more construction finance. That’s because loan approval rates always go down during a recession. Moreover, there is a major fear of inflation, which can push interest rates back up. Therefore, securing construction loans will remain difficult, especially for SMEs. The problem is compounded by the fact that many small businesses took a hit to their credit rating during the pandemic.
That said, with the demand so high, alternative construction finance providers should step up. This means that SMEs that need support should start looking for it away from banks and other traditional financing providers.
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