When embarking on a new construction project, one of the critical considerations is securing adequate financing. Understanding the breakdown of costs and how lenders typically allocate funds for different components is essential for developers and borrowers. In construction financing, costs are broadly categorized as hard costs and soft costs. Hard costs refer to expenses directly associated with the physical construction, while soft costs encompass non-physical expenses such as design, permits, and fees. In this article, we delve into the percentage of costs lenders typically fund for new construction projects and explore the division between hard and soft costs.
Understanding Hard Costs and Soft Costs
Hard Costs: Hard costs constitute the expenses directly linked to the physical construction of a project. This includes materials, labor, equipment, site preparation, foundation work, framing, electrical and plumbing systems, and other similar elements. Hard costs are tangible, measurable, and generally more straightforward to estimate compared to soft costs.
Soft Costs: Soft costs encompass a range of non-physical expenses that support the construction project. These costs are associated with the pre-construction and post-construction phases and include architectural and engineering fees, permits and inspections, legal and accounting fees, financing costs, marketing expenses, and contingencies. Soft costs are often more difficult to quantify accurately, as they are influenced by various factors such as project complexity and location.
Lenders play a vital role in financing new construction projects, and their approach to funding varies based on several factors, including project type, developer experience, market conditions, and individual lender policies. While there is no fixed industry-wide standard, it is possible to identify common trends in the funding of hard and soft costs.
Hard Costs Funding: Lenders generally tend to provide a higher percentage of funding for hard costs compared to soft costs. This is primarily due to the tangible nature of hard costs, which allows lenders to more accurately assess the value and risk associated with these expenses. On average, lenders may provide financing for around 70% to 80% of hard costs, although this can vary based on the project and the borrower's qualifications. The remaining hard costs are typically covered by the developer's equity, construction loans, or other sources of financing.
Soft Costs Funding: Soft costs often present more uncertainty and are considered riskier from a lender's perspective. As a result, lenders may be more conservative in funding soft costs and typically provide a lower percentage compared to hard costs. The range of funding for soft costs can vary significantly, but it is common for lenders to cover approximately 50% to 70% of these expenses. Developers are typically expected to contribute a higher portion of soft costs from their own equity or seek alternative financing options.
Factors Influencing Funding Percentages
Several factors influence the specific percentages of hard and soft costs that lenders are willing to fund:
Project Complexity: The complexity of a construction project affects the perceived risk for lenders. More complex projects may result in higher soft costs and lower lender funding percentages.
Developer Experience: Lenders consider the track record and experience of the developer. Experienced developers with a successful history of completing similar projects may have a higher chance of securing higher funding percentages.
Conclusion
When seeking financing for new construction projects, it is crucial for developers and borrowers to understand how lenders typically allocate funds
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By: Creative Global Funding Services Title: Analyzing Lenders'' Funding of Hard and Soft Costs in New Construction Sourced From: www.youtube.com/watch?v=iACELA8_qYo
