A construction-to-permanent loan is a single loan, closed once, that funds construction through draws and then converts into permanent, amortizing debt when the completed project passes the lender’s conversion tests. The borrower avoids a second closing and a separate takeout, and the lender that financed construction becomes the long-term lender on the stabilized property.
How does a construction-to-permanent loan work?
The loan has two phases under one set of documents. During the construction phase it behaves like a construction loan: the lender funds the budget through draws against completed work on a draw schedule, interest is paid on the amount drawn, the rate is commonly floating, and the sponsor gives a completion guaranty and often a repayment guaranty.
At conversion the loan becomes permanent debt. The balance stops growing, principal amortization begins or is scheduled to begin after an interest-only period, the rate is set for the permanent phase, and the recourse commonly steps down or burns off. The permanent phase then runs to its own maturity date, where the remaining balance comes due as a balloon payment.
The loan documents set a conversion date, or a window, and the conditions the project must meet.
What are the conversion tests?
The tests confirm that the completed project is the property the permanent loan was underwritten on.
Completion: the improvements are finished under the plans, a certificate of occupancy has been issued and lien waivers delivered. Occupancy or stabilization: the property has reached a stated percentage of leased or occupied space. Coverage: the property’s net operating income covers the permanent loan’s debt service, measured as a debt service coverage ratio or a debt yield at the amortizing payment, not at the interest-only construction payment. No default: no event of default exists and the guarantor still meets any liquidity and net worth covenants.
Illustrative example:
| Conversion test | Requirement in the loan documents | Project at conversion date | Result |
|---|---|---|---|
| Completion | Certificate of occupancy and final lien waivers | Delivered | Pass |
| Occupancy | 90% of units leased | 92% leased | Pass |
| DSCR on permanent debt service | 1.25x minimum | $3,000,000 NOI against $2,400,000 debt service, 1.25x | Pass |
| Permanent loan amount | $30,000,000 | Sized at 1.25x, $30,000,000 supported | Converts at full amount |
How is the rate set at conversion?
The permanent rate is set in one of three ways, and the loan documents state which. Some loans fix the permanent rate at the original closing, so the borrower knows the long-term cost before construction begins. Some set it at conversion as a spread over an index or a reference rate in effect on the conversion date. Some keep the loan floating and require or permit the borrower to fix the rate with an interest rate swap at conversion.
The hedge requirements change with the phase. A floating construction phase commonly requires an interest rate cap; a permanent phase that is fixed by swap replaces the cap with the swap and its documentation.
How does it compare with a construction loan plus a separate takeout?
The alternative is two loans: a construction loan that matures at completion and a permanent loan from another lender that repays it.
| Feature | Construction-to-permanent | Construction loan plus takeout |
|---|---|---|
| Closings | One | Two, with a second set of documents and closing costs |
| Permanent lender | Same lender | Chosen at completion from the lenders active at the time |
| Takeout risk | Removed if the conversion tests are met | Borne by the borrower until the permanent loan closes |
| Rate certainty | Available at closing if the permanent rate is fixed up front | Set when the permanent loan is priced |
The single-closing structure trades flexibility for certainty: the borrower gives up shopping the permanent loan on a stabilized asset and accepts terms set on a projection, and in return removes the risk that the takeout market moves before the project stabilizes.
How construction-to-permanent loans show up in LoanBoss
LoanBoss handles construction loans with draws entered on the day they are made, critical date alerts, hedges with live rates and mark-to-market values, and recourse tracking with burndown, and it models interest-only periods and custom amortization schedules, so the construction phase, the conversion date and the amortizing permanent phase are all tracked in one portfolio.
Frequently Asked Questions
What happens if the project fails the conversion tests?
The loan documents govern. Common outcomes are an extension of the construction phase if the documents allow one, a paydown to the balance the income supports, or a maturity default that the borrower must cure by refinancing or selling.
Is the interest rate the same in both phases?
Not necessarily. The construction phase is commonly floating; the permanent phase is fixed at closing, at conversion, or by a swap, as the loan documents provide.
Does the guaranty go away at conversion?
Commonly it steps down or burns off once the completion and coverage tests are met, but the loan documents set the terms, and the non-recourse carve-outs survive for the life of the loan.
Is a construction-to-permanent loan the same as a mini-perm?
No. A mini-perm is a short permanent loan, commonly a few years, that bridges completion to a long-term takeout. A construction-to-permanent loan converts to its own long-term permanent phase without a further refinance.
Who offers construction-to-permanent loans?
Lenders that hold both construction and permanent loans on their own balance sheet, since the same lender carries the loan through both phases.
Related Terms
- Construction Loan
- Draw Schedule
- Balloon Payment
- Interest-Only
- Debt Service Coverage Ratio
- Construction Loan Draw Tracking for Real Estate Developers: The Borrower’s Side
- Recourse and Guaranty Burndown: Tracking Guarantor Exposure Across a CRE Portfolio
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary