Rehab and construction loans are a huge part of lending. They are excellent products that offer significant value to borrowers across the nation. When done right, it provides the capital and opportunity for regular people to buy properties and add value to them. Often called “flippers”, they find properties that need some “love” and bring them back to life. Many times, and hopefully most of the time, for a profit.

Another side of the same coin would be construction lending. Construction and rehab loans can be similar, though in my mind, they are very different. While rehab loans start with a house that’s already built but needs upgrades, construction loans typically start from scratch and are built up from the ground up.

How are they different from “normal” loans?

Most loans use what is called “as-is” value. That is the current value with no upgrades or changes. When you are doing a rehab loan, you typically base the loan on the “After Repair Value” or ARV. How do you get the ARV? Typically, through an appraisal, however, the appraiser will need to know what you plan on doing with the property. Usually, the borrower or lender will provide a list of work along with the amount they will spend on upgrades. Then the appraiser can go and find comparable properties with similar upgrades or finishes.

Before the work begins

This is where it gets tricky. To properly start the process, you need a contractor bid and a lender ready to lend. As a lender, you have to know that the contractor’s list of work and the order of stages make sense and can be relied on.

One way to make this happen is by using a PCR, or Pre-Construction Budget Review. A 3rd part fund control company typically does these before you fund the loan. They will review the budget, do a search on the contractor for outstanding liens or lawsuits, and then give you a summary based on their review. Sometimes the review will come back with recommended changes to the budget or draw schedule before you fund the loan. The few times I’ve done these types of loans, the person doing the PCR is a contractor and they will give their 3rd party input on whether or not the budget makes sense.

Not everyone’s cup of tea

My Input? I don’t like these types of loans. It’s not that they aren’t good loans, but they require a significant amount of work. Some lenders specialize in this type of lending, and it’s literally all they do every day. Whether they have years of experience in this type of lending or are a licensed contractor who has transitioned into lending, they possess the expertise to manage these loans effectively.

I joke that the “real work” on rehab or construction loans doesn’t actually start until after the loan funds. Obviously, there is truth behind most jokes, and frankly, I prefer to have the work done once the loan funds.

In summary, rehab and construction loans are a great tool and can be a fantastic product when done by the right lender. Tools like PCR and a third-party fund control company can offer another layer of protection and expertise to ensure the transaction is as smooth as possible.

Reach out if you have any questions on this type of lending, and I’d be happy to discuss.