What is a construction loan?

A construction loan funds the period between a decision to build and a finished, working asset. Three features distinguish it from every other kind of facility.

It is drawn in stages, not advanced at once. Funds are released against progress that has been achieved and verified, so exposure grows only as value is created. The mechanism is deliberate: a lender that funded the whole budget on day one would be unsecured against an intention.

It is not serviced by the asset. A half-built facility earns nothing. Interest during construction is typically capitalised or funded from a reserve within the budget, which means the balance grows through the build even where the borrower is fully performing.

It matures shortly after completion. The facility is written for the build plus a short tail, not for the life of the asset. That maturity is the defining feature of the instrument and the reason the next section exists.

The risk being taken is completion risk: that the asset gets built, at approximately the budgeted cost, on approximately the expected schedule, to the specification that the capital replacing this facility is expecting. Everything in the documentation is aimed at that one exposure.

A construction loan is repaid by something other than the project's operations, and that something is the takeout. There are four ordinary forms and they are not interchangeable.

• A term or project financing on the completed asset. The asset, now built and contracted, supports long-dated capital sized on its cash flow. This is the standard path and it depends on the completed asset satisfying a coverage test — see [project finance](project-finance) and [debt service coverage ratio](debt-service-coverage-ratio).
• A sale of the completed asset, or a forward sale agreed before or during construction, where a buyer commits in advance and the developer retains completion risk.
• A [sale-leaseback](sale-leaseback) of the finished asset, which repays the build and converts the developer's position into a rent obligation while use continues.
• Equity, by design or by accident. The sponsor funds the repayment itself. Chosen deliberately this is a legitimate plan; arrived at because nothing else was available, it is the failure the other three are structured to avoid.

The rule that follows is the reason this page exists. The takeout has to be identified before the build starts, not sought when the facility approaches maturity. A facility maturing into a market that has moved, an asset that is not contracted, or a coverage test that no longer clears is the standard way a solvent project becomes a distressed one. Whoever funds the construction will ask what repays them on day one, and a credible answer to that question is a condition of the build being funded at all — which in practice means the [offtake](offtake) that will support the takeout has to be well advanced before the first draw.

Because the exposure is completion, the controls are all mechanisms for verifying that completion is still achievable with the money remaining. They recur with little variation across markets.

• A fixed draw schedule tied to milestones, with each request supported by evidence of the work actually done.
• Independent certification. A technical adviser or independent engineer, reporting to the parties funding the build rather than to the sponsor, confirms progress and cost before funds are released.
• The cost-to-complete test. At every draw, the undrawn commitment plus remaining equity must be sufficient to finish the job. When it is not, funding stops until the gap is filled. This is the single most important covenant in the facility and the one most likely to be tripped.
• Retention. A portion of each payment to contractors is withheld until completion, so the contractor retains an incentive to finish and defects have a fund behind them.
• Lien and payment discipline. Evidence that subcontractors and suppliers have been paid, so claims do not attach to the asset behind the lender's position.
• Contingency inside the budget, with defined control over when it may be used. A contingency the sponsor can spend freely is not contingency.
• Sponsor completion support. An undertaking to fund cost overruns and to complete the asset. This is the specific recourse that survives even in structures described as non-recourse, and it is why the sponsor's own balance sheet is examined on a project financing.
• Defined completion tests. What the asset must demonstrate before the build is treated as finished — capacity, availability, performance — because the takeout will not fund against anything less.

The mechanics above are the same for a warehouse and a hyperscale facility. Three things about this sector make them bind harder.

Energisation is a completion condition nobody on the deal controls. A facility is not complete when the building is finished; it is complete when it has firm power. Interconnection timelines are set by utilities and queue positions, and they move — the reasons are set out at [speed-to-power](speed-to-power). A facility with a maturity date and a completion test that depends on a third party's schedule carries a risk that no amount of construction discipline retires. Where behind-the-meter generation is the answer, the generation build becomes a second construction project inside the first, with its own equipment, permits and completion tests.

Long-lead equipment is ordered years before there is an asset. Turbines, transformers and switchgear are quoted far ahead and require substantial payments at order. The capital funding those deposits is exposed to a manufacturing slot rather than to a building, and security over it is a different problem from security over work in place — which is why supplier obligations at this stage are frequently supported by a [letter of credit](letter-of-credit) rather than by asset security.

The layers do not complete at the same time. The shell, the generation and the compute finish on different schedules, and the compute may be delivered before there is power to run it. Building all three inside one facility with one maturity forces the earliest-maturing exposure to wait for the slowest layer, which is the [tenor](tenor) problem appearing during construction rather than after it. Separating the builds so each is funded and taken out on its own schedule is the structuring response, and it is the same logic that runs through the whole [capital stack](the-data-center-capital-stack).

Continuum's work here is sequencing: establishing what each layer needs to reach completion, what takes each one out, and coordinating the parties so the takeout exists before the first draw rather than after the last one.