Commercial Real Estate Construction Loans: All You Need to Know
Navigating the world of commercial real estate (CRE) can be complex, especially when it comes to financing new developments. Whether you’re a seasoned developer or a business owner looking to construct your own facility, understanding commercial real estate construction loans is critical. These loans provide the capital necessary to bring commercial buildings from blueprint to reality. In this guide, we’ll explain how they work, when interest starts accruing, and current industry rates—giving you a solid foundation to make informed investment decisions.
How Do Commercial Real Estate Construction Loans Work?
Commercial real estate construction loans are short-term, high-interest loans specifically designed to fund the construction of income-generating properties such as office buildings, retail centers, warehouses, and multi-family apartment complexes. Unlike traditional mortgages, which are paid out in a lump sum, construction loans are typically disbursed in stages—also known as “draws”—that align with various milestones in the construction process.
Before loan disbursement begins, borrowers must submit a detailed construction plan, budget, project timeline, and contractor agreements to the lender. Once approved, funds are released in increments based on verified progress. For example, the first draw might cover land clearing and foundation work, the next draw for framing, and so on, until project completion.
Lenders closely monitor each phase to ensure that construction aligns with the approved plan. Often, inspections are required before funds are released for the next stage. This keeps risk to a minimum and ensures that the investment is progressing according to schedule.
Typically, the borrower makes interest-only payments during the construction period. Once the project is complete, the loan is either converted into a long-term mortgage (a process known as “permanent financing”) or paid off through the sale or lease of the property.
This staged funding model benefits both lender and borrower. The lender reduces risk by controlling fund disbursement, while the borrower gains flexibility and access to capital without paying interest on the full amount upfront.
When Does Interest on Commercial Real Estate Construction Loan Accrue?
Interest on a commercial real estate construction loan begins to accrue as soon as funds are drawn—not when the entire loan is approved. Because these loans operate on a draw schedule, borrowers only pay interest on the amount of capital they’ve accessed, not the full approved sum.
For example, if a $5 million loan is approved but only $1 million has been drawn for the first phase of construction, interest is calculated based on that $1 million. As more draws are made, the interest obligation increases proportionally.
The loan typically comes with an “interest reserve” built into the total loan amount, which is used to cover interest payments during the construction period. This helps reduce out-of-pocket costs for the borrower while the project is still under development and not yet generating revenue.
It’s also important to note that interest accrues monthly, and missed payments can lead to serious financial and legal consequences, including the possibility of foreclosure. Therefore, having a reliable contractor and a realistic project timeline is essential to minimize costs and avoid delays.
Once the construction phase ends, the loan must either be paid off in full or transitioned into a more traditional commercial mortgage with its own amortization schedule and interest structure. At this point, interest starts to accrue based on the terms of the new financing agreement.
Commercial Real Estate Construction Loan Rates
Commercial real estate construction loan rates are typically higher than rates for standard commercial mortgages due to the increased risk and complexity involved. Construction projects are inherently uncertain, subject to cost overruns, delays, and market fluctuations, which justifies the higher interest costs for lenders.
As of 2025, commercial construction loan interest rates in the U.S. generally range between 6.5% and 12%, depending on several key factors:
- Borrower Creditworthiness: Lenders evaluate your credit score, financial history, and experience with similar projects. Strong credentials can earn you a more favorable rate.
- Loan-to-Cost (LTC) Ratio: This is the ratio of the loan amount to the total project cost. Lower LTC ratios signal lower risk and can lead to better interest rates.
- Project Type and Location: Commercial developments in high-demand areas like urban centers tend to qualify for lower rates, while speculative or rural projects may be priced higher.
- Economic Conditions: Central bank policy, inflation, and the real estate market cycle all influence prevailing interest rates.
- Lender Type: Banks, credit unions, and private lenders each offer different rate structures. Banks tend to offer the most competitive rates but may require stricter qualifications.
In addition to base interest, borrowers may face other charges, such as loan origination fees (usually 0.5% to 2% of the loan amount), underwriting fees, inspection fees, and legal expenses. These should all be factored into the overall cost of financing.
Some lenders offer adjustable-rate construction loans, where the interest rate changes over time in response to the prime rate or another index. While these can offer savings if rates drop, they also carry the risk of increasing costs in a volatile market.
To secure the best possible rate, it’s advisable to obtain multiple loan quotes and consult with a real estate finance professional who can help assess options based on your specific project needs.
Conclusion
Commercial real estate construction loans are vital tools for developers and investors seeking to bring new commercial properties to life. While they offer the necessary capital to complete ambitious projects, they also come with unique complexities, such as staged funding, interest-only payments, and higher risk exposure.
Understanding how commercial real estate construction loans work, when interest accrues, and what current loan rates look like can position you for greater success in the real estate market. Proper planning, a solid construction team, and strong financials are key to leveraging these loans effectively.
Whether you’re developing an office complex, retail space, or a multi-unit residential building, securing the right construction loan is the first major step toward a profitable investment.
