The riskiest moment in a construction project is not breaking ground. It is the week the building is finished, the construction loan matures, and the sponsor has to find permanent financing for an asset with no operating history.
The refinancing cliff
Traditional construction financing is a short-term loan that matures at or shortly after completion. The sponsor is then refinancing into permanent debt at the worst possible moment: the project is newest, the income is unseasoned, and any delay in the build has eaten into the window. If the market has moved or lease-up is slower than projected, the takeout that looked certain at origination may not be there.
What conversion changes
A facility structured to convert removes the cliff by underwriting both halves at the same time. The construction phase funds the build through draws; on completion, and subject to defined conditions, the same loan converts into a permanent, low-interest loan rather than being repaid by a new lender. One underwriting desk carries the project from breaking ground to stabilisation.
Key takeaways
- Conversion is not automatic — it is contingent on completion conditions defined at closing.
- The value of the structure is that those conditions are known on day one, instead of being set by whatever the market offers on the day the loan matures.
The conditions typically tested at conversion
- Completion. A certificate of occupancy or equivalent sign-off, and the work substantially complete per the approved plans.
- Lien clearance. Final lien releases from the contractor and subcontractors, and a title endorsement confirming no intervening liens.
- Valuation. An as-completed appraisal supporting the permanent loan amount.
- Income or occupancy thresholds. On income property, a minimum occupancy or debt-service-coverage test.
- No default. The loan performing and in good standing through the construction phase.
None of these are unusual. The point is that they are written down at closing, so a sponsor can build toward a defined target rather than toward an unknown lender's future appetite.
What it asks of the sponsor
Because the lender is committing to the back end, the front-end underwriting is more thorough. Expect real scrutiny of the budget's contingency and interest reserve, of the contractor's capacity, of the plans' permitting status, and of the as-completed value. A sponsor who wants certainty at the end should expect to earn it at the beginning.
Where we fit
We finance construction on luxury residential, apartment, retail, commercial, industrial and hotel properties up to 90% of loan-to-construction-cost and $75 million, structured as short-term loans that convert into a permanent, low-interest loan when construction completes. If you are weighing a converting facility against a construction loan plus a separate takeout, it is worth running both — see our note on LTC for how the sizing works.
General information only, not construction, legal or investment advice. Call (800) 943-1314 to discuss a specific project.
Published by the US Lending & Company underwriting desk. General information only — not legal, tax or investment advice. NMLS #244778 · DRE #01516868.