Construction Loans: what they are and why they attract qualified investors

Understand how construction loans work and how they provide exposure to the real estate sector without direct property ownership

Construction loans are financial instruments used to finance construction or renovation projects, typically with terms ranging from 6 to 24 months.

Popularized in the United States, these loans are often used as an alternative investment by qualified investors seeking consistent returns and exposure to the real estate sector, without directly acquiring properties.

How do construction loans work?

Unlike traditional financing, construction loans are disbursed in stages (draws), according to the physical progress of the project. The funds are used to finance residential or commercial construction, with a short maturity, and are repaid in full at the end of the project or refinanced.

Structuring these loans requires rigorous analysis of the project, the developer or builder, the land, and the required permits and licenses.

These loans are primarily originated by private lenders or specialized real estate debt funds, rather than conventional banks.

Key characteristics

• Real collateral: the property under construction serves as collateral. In the event of default, the asset can be foreclosed.
• Rates and interest: due to higher risk, interest rates are higher than conventional loans, with annual averages between 8% and 14%. Origination and exit fees may also apply.
• Short-term: typically between 6 and 24 months, which can offer faster capital returns, provided the project is executed according to schedule.

Why do qualified investors seek this type of asset?

Experienced investors with higher risk tolerance consider construction loans as part of a diversification strategy for the following reasons:

1. Exposure to real estate without buying property

They allow investors to capture the appreciation potential and income generation of U.S. real estate without the challenges of direct asset management.

2. Higher returns than traditional fixed income

Compared to government bonds or bank products, construction loans offer higher risk premiums, with returns varying according to project quality and contractual structure.

3. Tangible collateral

Having the property as collateral reduces the risk of total capital loss, especially when the loan is well structured and the loan-to-value (LTV) ratio is conservative.

4. Low correlation with traditional financial markets

Financed real estate assets tend to be less volatile and less correlated with equities or government bonds, providing protection within broader portfolios.

What are the average returns on construction loans?

Returns vary based on project risk, the developer’s experience, the region, and the investment vehicle used (private funds, crowdfunding platforms, among others). In general, however, construction loan returns tend to outperform traditional fixed-income investments such as government bonds and bank products.

See a comparison below:

• Construction Loans: average annual returns of 7% to 11%, depending on project risk, collateral, and the developer’s profile.
• High-Yield Savings: high-yield savings accounts and Certificates of Deposit (CDs) in the U.S., with returns ranging from 4% to 5.5%.
• U.S. Government Bonds: considered a lower-risk benchmark, U.S. Treasury bonds yield between 4.1% and 4.4% per year.

It is important to remember that not every project offers the same level of attractiveness and security. Therefore, specialized analysis is essential to identify opportunities that combine solid returns, strong collateral, and alignment with your investor profile.

Risks and considerations

Despite their attractive return potential, construction loans are not risk-free. Key risks include:

• Risk of borrower default
• Risk of collateral execution in markets with limited liquidity
• Construction delays affecting draw schedules and repayment
• Regulatory and permitting risks

For these reasons, it is essential that investors have technical knowledge or specialized advisory support to conduct a detailed analysis of projects and contractual terms.

A sophisticated option for alternative allocation

Construction loans are financial instruments that can complement the portfolios of qualified investors as a means of diversification, access to the real estate sector, and passive income generation over intermediate time horizons. Their profile requires careful analysis, enhanced risk control, and experience in alternative investments, making them less suitable for beginners or conservative investors.

At Upside Investment, we monitor movements in the U.S. real estate market and assist investors in evaluating structured assets and debt funds with strong return potential and solid collateral. If you are looking to explore alternatives beyond traditional investments, speak with our team.