Financing Your Ground-Up Construction Project:

Insights, Strategies, and Best Practices with Montgomery Lending

Starting a ground-up construction project is an exciting venture, but securing the right financing is essential for success.

At Montgomery Lending, we aim to empower our clients with clear insights into the financing process, dispel common myths, and share strategies to optimize your project’s outcome while managing risks effectively.

This guide explores how ground-up construction loans work, highlights potential pitfalls, and offers practical advice for maximizing your investment.

Key Elements of Ground-Up Construction Loans

Ground-up construction financing typically consists of three core components:

Land Value:

Assessed at its current market value, without considering future enhancements from permits or development plans.

Hard Costs:

Direct expenses related to physical construction, such as materials, labor, and heavy equipment.

Soft Costs:

Indirect expenses like architectural designs, engineering studies, and permitting fees.

While essential to the project, these costs are often excluded from the lender’s loan calculations.

Calculating the Loan-to-Cost (LTC) Ratio

At Montgomery Lending, we determine the financing structure using this formula:

Land Value (Market Rate) + Hard Costs = Total Project Cost

The Loan-to-Cost (LTC) ratio reflects the percentage of the total project cost we’re prepared to finance.

Montgomery Lending typically offers loans at 80% LTC, with interest rates between 10.25% and 10.75% and origination fees ranging from 1.25 to 1.75 points.

While some lenders may provide higher LTC ratios, such as 87.5%, this can lead to unexpected challenges.

The Risks of Over-Leveraging

Opting for a higher LTC, like 87.5%, might seem appealing for reducing upfront capital needs, but it often comes with steeper costs.

Increased leverage typically results in higher interest rates and fees applied across the entire loan, not just the additional amount borrowed.

Key considerations include:

Elevated Interest Rates: Moving from 80% to 87.5% LTC can raise the interest rate by 0.75% to 1.25% (75–125 basis points).

Higher Origination Fees: Fees may increase from 1.25%–1.75% at 80% LTC to 2% or more at 87.5% LTC, calculated on the full loan amount.

Example Scenario

Consider a project with a $10 million total cost:

☑️Loan at 80% LTC:
☑️Loan Amount: $8 million
☑️Interest Rate: 10.25%
☑️Origination Fees: 1.25%
☑️Total Financing Cost (interest + fees): $920,000

✅Loan at 87.5% LTC:
✅Loan Amount: $8.75 million
✅Interest Rate: 11.25%
✅Origination Fees: 2%
✅Total Financing Cost: $1,156,250

^^^Borrowing an additional $750,000 at 87.5% LTC increases the financing cost by $236,250, a 31.5% annual increase for the extra funds.

This added expense can often be avoided by contributing more equity or partnering with an investor.

Strategic Alternatives to High Leverage

Montgomery Lending encourages smarter financing approaches to keep costs manageable:

Increase Equity Contribution:

Investing more of your own capital reduces the loan size, lowering both interest and fees.

Engage Co-Investors:

Partnering with an investor to bridge the funding gap can minimize reliance on costly high-leverage loans.

While co-investors may seek a portion of the profits, this is often a more economical option than the inflated costs of over-leveraging, which can strain project budgets.

Best Practices for Success

Ground-up construction projects carry inherent risks, but strategic financing decisions can pave the way for success.

By understanding Mongomery Lending’s loan structures and carefully weighing the costs of higher leverage, you can protect your investment and achieve better outcomes.

Our recommendation: Balance leverage with equity, and explore investor partnerships to keep financing costs sustainable.

Connect with Montgomery Lending

Ready to finance your next construction project?

Our team is here to provide tailored solutions and expert guidance: