The capital stack, in plain language
Every development is funded by a stack of capital with different risk, cost, and control:
- Senior construction loan — the cheapest and biggest layer, first in line on the collateral. Sized against loan-to-cost (land + hard costs + soft costs + reserves) and cross-checked against the stabilized value of the finished project.
- Mezzanine debt / preferred equity — optional middle layers that push total leverage higher when sponsor equity is short. More expensive than senior debt, cheaper than giving up common equity — and every senior lender has rules about whether and how they may sit behind it.
- Sponsor equity — expect to have real skin in: most construction lenders want 25–40% of total project cost in equity (cash, and sometimes credited land value if you've owned the parcel).
Bank vs. debt fund vs. private — the actual trade
| Bank / credit union | Debt fund / private lender | |
|---|---|---|
| 2026 pricing (typical) | ~SOFR + 275–400 bps | ~SOFR + 400–550 bps, sometimes more |
| Leverage (LTC) | ~65–75% | Higher — some programs materially so |
| Recourse | Usually full recourse during construction | Varies — sometimes limited, priced in |
| Covenants & process | More of both; slower close | Fewer, faster, more flexible |
| Best when | Strong sponsor, patient timeline, cost matters most | Speed, leverage, or a story the bank won't underwrite |
Deposit relationships matter on the bank side — construction lending is often relationship lending, and a sponsor's operating accounts are part of the negotiation.
What lenders actually underwrite
- The sponsor — track record on comparable projects, plus financial covenants that commonly scale with the loan (net worth and liquidity tests are standard; exact thresholds vary by lender).
- The budget — a third-party review of hard costs, real contingency (5–10%+), and an interest reserve carrying the project through construction (the construction mechanics guide explains reserves and draws — the machinery is the same at scale, with more inspection).
- The exit — the number that decides your leverage more than any other: will the stabilized project support permanent debt? Lenders test projected NOI against a stabilized DSCR (commonly ~1.20–1.25+) and often a debt-yield floor. If the proforma rents don't clear the exit test, the construction loan shrinks until they do — and the equity requirement grows to match.
- The market — feasibility support for those proforma rents and the absorption timeline. Optimistic lease-up assumptions are the proforma's most common lie; underwrite the NOI math like a buyer would.
Recourse, completion guarantees, and the fine print that owns you
Most construction loans are full recourse during construction — the sponsor personally backstops completion. Even “non-recourse” structures carry completion guarantees and carve-outs (“bad-boy” provisions) that restore personal liability on specific events. None of this is exotic or avoidable at normal leverage — but every word of it is negotiable at the term-sheet stage and immovable after closing. This is the single best place in the process to spend money on a real estate attorney.
California-specific realities
- Entitlement timelines vary dramatically by jurisdiction — and your land carry and soft costs run the whole time. Most construction lenders want entitlements largely resolved before closing; the riskier entitlement phase is usually funded with equity or specialty land/pre-development capital.
- Insurance during construction (builder's risk) is its own underwriting problem in fire-prone areas — price it before you buy the site.
- Labor and prevailing-wage requirements attach to some project types and programs and change the budget materially — a question for your GC and attorney early, not at draw three.
The process, realistically
From complete package to closing, expect 60–90+ days at a bank (debt funds move faster): term sheet → third-party reports (appraisal on as-complete and stabilized values, budget review, environmental) → committee → legal. The package that moves fast is the one that arrives complete: sponsor financials and track record, full budget with contingency, proforma with market support, entitlement status, and the GC's credentials. Sponsors who treat the first lender meeting like a pitch meeting — with the materials a committee needs — get materially better execution.