Floor Loan Definition

Floor Loan

Investopedia / Candra Huff

What Is a Floor Loan?

A floor loan is a specific kind of loan designed specifically for real estate construction projects. Floor loans apply to buildings that will be occupied by tenants. The floor loan is the minimum amount that a lender agrees to advance in order to enable the builder to commence the development of a commercial property.

How a Floor Loan Works

A floor loan does not function like a traditional loan or a traditional mortgage, in which the borrower receives the funds in their entirety in one lump sum. Instead, the floor loan is the partial amount of a larger loan—the sum that the borrower and builder need in order to actually begin the construction project.

The rest of the loan, called the "holdback," is paid after the builder reaches certain stages in the project that are decided upon by the lender. For example, a bank may agree to advance 70% of the total project cost, with the balance of 30% to be released upon the project achieving certain milestones. These milestones typically include a successful sale or lease of the majority of the project's units, obtaining an occupancy permit, etc.

Borrowers who fail to meet the requirements for the holdback might have to secure a bridge loan or some other form of gap financing or mezzanine financing in the interim, which can be quite costly: These loans are processed quickly, but have very short terms and high interest rates.

Floor loans are available only for the construction of commercial real estate projects, not residential ones.

Floor Loans vs. Construction Loans

The floor loan is often the first stage of a larger construction loan or mortgage. A construction loan is a short-term loan (a loan whose term is a year or less) used to finance the real estate project. The builder takes out a construction loan to cover the costs of the project before obtaining long-term funding. Because they are considered fairly risky, construction loans usually carry higher interest rates than traditional mortgages do.

Home-buyers who custom-build their own residence can take out construction loans, but they cannot opt for a floor loan as part of the process. Floor loans are only a part of construction loans for tenant-occupied buildings, not owner-occupied ones. An individual homeowner can, however, refinance the construction loan into a permanent, longer-term mortgage, or simply can take out a new loan to pay off the construction loan.

In the case of a real estate project that is a commercial piece of property (retail centers, office complexes, hotels, and non-owner-occupied apartment buildings), the builder can fund the project with a construction loan and then take out a commercial real estate loan to pay it off. (A commercial real estate loan is a specific kind of mortgage loan secured by a lien on commercial, rather than residential, property. As such, it is unavailable to individual home builders.)

Commercial real estate loans tend to have longer terms than construction loans, ranging from five to 20 years.