A real estate investor who finances individual properties for a buyer or a builder has the opportunity to pick and choose the place and time to invest. The returns are typically far greater than other market options with investors routinely gaining double digit returns acting as a bank.

Yet typically such investors construction loansare involved with the acquisition and remodeling of existing properties and while that is certainly an attractive option investors can also profit by providing financing for new construction. New construction is similar to financing an existing property yet financing for new construction is always for the short term, not for a long term hold.

Private investors as well as commercial banks can provide the funds needed to finance new construction but establishing a loan basis is a bit different. For existing properties, the lender uses an appraisal of the property to establish a value and loan amount. For new construction, the value is based upon the property being completed, even though not a single bucket of dirt has been shoveled.

The bank reviews the plans and specifications of the home and asses a “Subject To” value. This means the bank considers existing real estate and compares it with the home yet to be constructed. After reviewing a builder’s plans, the bank hires an appraiser who will arrive at a value “subject to” the property being completed as laid out in the drawings.  The financier then considers the cost to construct by adding up all the numbers provided by the builder for things such as hammers and nails along with required permits and zoning fees.

A 20 percent equity position is common and however much it cost to build the new home, the loan must be no greater than 80 percent of the “subject to” value. Once the loan is determined, construction begins. At the end of the construction loan, the lender wants its money back. The buyer will obtain a permanent mortgage from a mortgage company that replaces the existing construction loan plus any interest that is due. Construction loans are for the short term and provide investors with their returns once the home is completed.