Real estate development loans are a type of financing for developers who want to purchase raw land and carry out development on it. The loan is considered a short-term acquisition loan since the funds are being dispersed to prepare the grounds for further construction or sale. You would use a land development loan primarily to cover the costs associated with acquiring land, preparing it for further development, and obtaining the necessary permits and approvals. In most cases, subsequent loans are necessary to pursue further development on the land once it has been adequately prepared for construction.
Below, you’ll find everything you need to know about real estate development loans and their unique role in the development process.
Understanding Real Estate Development Loans
Borrowers take out land development loans to make improvements to a plot of land, helping turn raw land into a building site through various preparations, such as clearing or grading the plot, leveling the area, or building roads. Land preparation can also include the building of utility infrastructure, setting up sewage, plumbing, power, water lines, or other vital connections.
Real estate development loans come in several types, including acquisition and development loans (A&D) or land purchase loans. Choosing the right type will depend on the location and scope of your project, as well as the preferences of your financial partners. Here’s what to know about the different types of these loans:
Acquisition and Development Loan
The acquisition and development loan, or an AD, combines the finances for the land acquisition and development costs into a single loan. ADs typically cover the costs associated with the purchase of land, installing the utility of street services, and preparing for construction. In most acquisition and development loans, the full funds for a project are not provided, and you will need to pursue subsequent funding to complete a project on the site.
Land Purchase Loans
Land or lot purchase loans fund the acquisition of a plot of land but do not allow for immediate development or construction. Land purchase loans are most appropriate for developers who have a plan for a plot of land but don’t plan to start immediate financing, development, or construction on a project. For example, you might use a land purchase loan when you want to acquire a plot of desirable land, but a project won’t be ready to enter development for another year or so.
Land development loans are for horizontal development, or in other words, a loan that allows you to complete the horizontal phase of a project (in this case, land preparations and utility infrastructure installation) and can bridge the gap before you secure long-term financing for a development project.
The Process of Obtaining a Land Development Loan
Lenders sometimes consider real estate development loans to be high-risk since the property won’t generate returns until the building is completed and operational, and the process for obtaining one can be involved. You may find that land development loans have stricter requirements for origination and come at higher interest rates. The specific eligibility for a land development loan can vary based on the nature of the project, state or local regulations, and the specifics of the plot of land. Even so, the application process is likely to include a few key steps that evaluate the qualifications of parties involved in the project and project viability:
Borrower Review
Lenders will want borrowers to demonstrate creditworthiness, and it’s important to be able to demonstrate both a positive reputation and project track record. State and local regulations mandate what paperwork is required for borrower review, but a property title search, mortgage insurance, and factors such as credit score, credit history, and debt-to-income ratios are common factors. Financial stability is also key, as lenders may want to secure an alternate form of repayment in case your project fails to deliver on ROI.
Contractor Review
General contractors (GCs) on the project may also be asked to demonstrate their financial standing, industry reputation, and past performance on development projects. The GC should be able to demonstrate an ability to successfully complete projects similar to the one planned on the land being acquired.
Experience & Track Record
Since real estate development loans are considered higher-risk, it’s especially important that you demonstrate prior project success, industry expertise, and the overall financial strength of your business. Modern real estate development software can play a key role in demonstrating your ability to bring projects in on time and under budget. Delivering accurate, easy-to-digest project reports from your portfolio to potential investors will help you demonstrate past success and strengthen your credibility in the loan origination process.
Development Plan and Feasibility
Offering lenders a comprehensive development and financial feasibility plan will also bolster your application for a land development loan. Ensuring your business plan, financial projections, and market analysis are solid and viable is one of the most important steps in securing funding.
Collateral
You can bolster a land development loan application by offering collateral to lenders. In many cases, the land itself may be sufficient collateral, depending on the estimated value and marketability. If lenders don’t feel the land offers sufficient security for the loan, you can also demonstrate an ability to repay the loan with alternate financing, either from your own funds or elsewhere in the capital stack. Before offering collateral as part of the land acquisition, you should take care to create a comprehensive budget for the upcoming project and evaluate risk.
Securing a land development loan is a key starting point for a project slated for development on raw land, and having the right documents or credentials prepared will help you navigate the origination process smoothly. Northspyre’s development platform can give you access to historical data and documents in a convenient Document Library, allowing you to navigate the origination process more smoothly.
Once land has been acquired and prepared for construction, you will need to pursue additional funding to complete the project, including additional loans from financial partners and institutions.
How Land Development Loans Differ from Other Real Estate Loans
Real estate development is a lengthy and complex process, and land development loans are just one type of financing you might leverage over a project’s life cycle. As such, it’s important to understand the distinct use case and role of each potential loan.
Here are the common loans a developer might take out for a project and the distinct function each serves:
Construction Loans
Construction loans are designed to fund the actual construction of buildings or structures on a development site, and the funds are typically dispersed in phases based on project milestones. You can use a construction loan to cover the cost of land, contractor labor, building materials, and permits.
Bridge loans
Bridge loans are short-term financing meant to bridge the gap between the completion of a real estate project and the availability of permanent financing or sale. In some cases, bridge loans are used to purchase raw land, usually when one intends to redevelop the land and sell it at auction.
Mezzanine Financing
Mezzanine financing is a hybrid form of debt and equity financing used in real estate development that gives the lender the right to convert debt to an equity interest in a company in case of default. In real estate development, mezzanine financing is often used to expand the scope of a real estate project.
Real estate development loans cover the cost of construction and development and in some cases, bridge the financial gaps before a property becomes profitable enough to generate significant revenue. In contrast, land development loans are designed for the acquisition of land and preparation for future development.
Land development loans are appropriate for when you’re looking to acquire a property, providing you with the funds necessary to secure land ownership and jurisdiction. The loans are also useful for sites that require an extended period of excavation or preparation before the construction phase can begin. Since land development loans are considered short-term, they offer a degree of flexibility, allowing you to secure long-term construction and permanent loans once a comprehensive plan for development is in place and the property is considered suitable for development.
Successful Land Development Loan Use Cases: A Closer Look
Land development loans are often used on development projects that require extensive investment to get a site ready for further development. Projects that involve redeveloping abandoned lots, or repurposing brownfield sites, are common use cases for this type of loan. Land requiring decontamination, grading, road construction, or utility installation will often require an extended period of preparation.
Here are a few high-profile projects that required extensive land development before proper construction could break ground:
Eastland Yards
Eastland Yards, a large-scale development project planned in Charlotte, North Carolina, is currently in an extensive excavation and infrastructure installation phase before the ground can be truly broken on the project. Initial crews will work to regrade and remove asphalt from the Old Eastland Mall, which used to operate on the site, and will work on underground infrastructure and upgrading utilities. The development will include multi-family homes and affordable housing, recreational areas, restaurants and commercial space, and more. The process, which began in 2022, was expected to take 18 months, with proper construction beginning in 2023 to meet the expected 2024 opening.
King's Cross Central
King’s Cross Central in London, U.K., is another example of a site that required site preparation before construction can break ground. The mixed-use development was built on an underused industrial site that was transformed into housing, squares and parks, shops, offices, and community art spaces. Before construction on any of these projects could begin, the site, which was once contaminated with coal, needed to be decontaminated and cleaned up. Over the past decade, interest in brownfield sites such as old train ad naval yards for major mixed-use development sites has increased. The sites, which help revitalize communities and provide much-needed housing amid shortages, often require extended periods of contaminant cleanup.
Similar development projects are likely to require initial financing to acquire and develop land, either grade and prepare raw land or transform aging infrastructure, and would likely require a land development loan to initiate the project.
Land development loans can play a key role in your development process, allowing you to secure a piece of land and prepare the property for construction or sale. For developers who need short-term financing to initiate a project and build out the necessary utility infrastructure, these loans can be a key source of financing. Northspyre’s real estate development platform can help you build key partnerships with lenders, leveraging historical data to compile reports and show your track record of bringing projects in on-time and under budget.
Book a Northspyre demo today and find out how the platform can help you foster positive relationships with financial partners for your next development project.
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Real Estate Development