Construction lending is not a larger version of a mortgage. It is a facility that pays out against progress rather than against a purchase, on an asset that does not yet exist in the form that gives it value, to a borrower whose ability to finish is the real security. Everything distinctive about it follows from those three facts.
In Spain the framework has particular features that international developers meet for the first time in the middle of a transaction, usually at the moment they were expecting to draw funds.
Nothing happens before the licence
The building licence is the first question and frequently the last. A lender will not fund construction against a plot where permission is pending, and the distinction between a licence granted, a licence applied for, and a project that merely complies with the planning instrument is one that borrowers blur and lenders never do. Some municipalities allow works to begin under a responsible declaration instead of an express licence, which shifts risk to the developer and is read by lenders accordingly. For a new building, though, state law sets the floor: article 11.4(b) of the consolidated Land and Urban Rehabilitation Law requires new building works to be authorised by an express act, with administrative silence counting as refusal, a rule the Constitutional Court left standing for buildings in judgment 143/2017.
Where the plot itself requires urban development work before it can be built on, that stage has its own costs, its own timetable and its own risk, and it does not belong inside a construction budget as a single line. A lender that finds development obligations buried in a build cost will reprice the whole facility.
The budget, and who signs it
A construction budget is credible when someone with professional liability has put their name to it. Broken down by chapter, with measured quantities, and reconciled to the project as licensed rather than to an earlier version. The two numbers that receive most scrutiny are the contingency, which is often too small, and the professional fees and taxes, which are often missing entirely.
Alongside the budget sits the works schedule. Lenders are less interested in the total duration than in what has to happen in the first quarter, because that is the period in which a project reveals whether its timetable was real.
The taxes inside the budget
The first is the municipal tax on constructions, installations and works. Under article 102 of the consolidated Local Finance Law its base is the cost of material execution of the works, and the article itself excludes VAT, local charges, professional fees, the contractor’s profit and any other item that is not strictly material execution cost. The rate is fixed by each municipality and may not exceed 4 per cent, and the tax accrues when the works begin, even if the licence has not been obtained. Article 103 provides for a provisional assessment when the licence is granted or at the other points it sets, on the budget submitted, endorsed by the professional association where that is compulsory, or on indices set by the municipal ordinance, and a final one on the real and effective cost once the works are finished, so an overrun in the build is also an overrun in the tax.
VAT shapes the cash flow more than the cost. Where works are contracted directly between the developer and the contractor for the construction of buildings intended mainly for housing, which the law defines as at least 50 per cent of the built surface, article 91 of the VAT Law applies the 10 per cent rate, and the same article applies that rate to the sale of buildings or parts of buildings suitable for use as dwellings, with up to two parking spaces and the annexes transferred with them, within the limits it sets, while it sets a 4 per cent rate for certain deliveries, including officially protected housing of the special regime or of public promotion delivered by its developer. Under article 84, for construction works contracted directly between developer and contractor, it is the developer as business recipient that accounts for the VAT, and the same shift applies where the recipient is itself the main contractor or another subcontractor. A budget that ignores either rule misstates the funding the project needs month by month.
Drawdown against certified progress
Construction facilities are drawn in tranches against certification. Progress is measured, certified by the technical team, checked by a monitor acting for the lender, and only then funded. That monitor is a cost the borrower carries and a protection the borrower should want: it is the mechanism that stops a project drawing ahead of value.
Two consequences follow. First, the developer needs working capital to be ahead of the certification cycle, since money arrives after the work rather than before it. Second, changes to the project have to be managed formally, because a variation that has not been certified is a variation that will not be funded. The same discipline applies in other jurisdictions, and our note on development and construction finance in the Netherlands sets out the comparison.
A construction lender is not funding a building. It is funding a sequence of certified steps, each of which has to be worth more than the money released against it.
Buyer deposits must be guaranteed
Where a residential developer takes money on account from buyers before delivery, Spanish law requires those amounts to be secured by a guarantee or insurance policy in the buyer’s favour, and held in a dedicated account. This is not optional and it is not a formality: failure here is an infringement of consumer legislation, a missing guarantee can be sanctioned with up to 25 per cent of the amounts whose repayment should have been secured or with the sanction set by the regional rules, and it is one of the first things a lender’s counsel checks.
The mechanics are in the first additional provision of the Building Act, Law 38/1999. The guarantee runs from the grant of the building licence, answers for repayment if construction does not start or is not completed within the agreed delivery period, and covers the amounts paid, applicable taxes included, plus legal interest; a surety insurance policy has to be individual to each buyer, and a bank guarantee has to be joint and several. The money has to be paid through a credit institution into a special account, separate from any other funds of the developer, which may be drawn only for expenses arising from the construction of those homes, and the bank opening the account has to require the guarantee. The guarantees are cancelled once the occupancy certificate, first occupation licence or equivalent document has been issued and either delivery to the buyer is accredited or the buyer refuses to take the home.
For a project relying on presales to demonstrate absorption, the guarantee facility is therefore part of the financing structure rather than an administrative afterthought, and its cost belongs in the budget.
Insurance and the obligations that outlive completion
Residential development in Spain carries a mandatory ten-year guarantee against structural damage, and insurers writing it as insurance ordinarily require technical control during construction by an independent body. Arranging it late, or discovering that the technical control was not appointed at the right stage, can delay delivery and therefore the exit. Alongside it sit the building book and the first occupation licence or the equivalent document, without which units cannot be delivered and the sales that were to repay the facility cannot complete.
The Building Act sets the frame. Article 19.1(c) describes the ten-year guarantee as damage insurance, surety insurance or a financial guarantee against material damage caused by defects originating in or affecting the foundations, supports, beams, slabs, load-bearing walls or other structural elements that directly compromise the mechanical strength and stability of the building, and article 19.5(c) sets the minimum sum at 100 per cent of the final cost of material execution, professional fees included. The second additional provision makes it compulsory for buildings whose main use is housing, subject to the exceptions it sets out, and under article 19.7 whoever was obliged to take it out answers personally if the rules are not met.
The guarantee also governs the exit. Under article 20.1 of the same Act, no public deed declaring the new construction of a building to which the Act applies may be authorised or registered unless the article 19 guarantees compulsory for that building are accredited. And for a completed building, article 28.1 of the Land and Urban Rehabilitation Law requires the notary, and in turn the registrar, to see a technician’s certificate that the works were finished in line with the project, evidence that the requirements of building legislation for delivery to users are met, and the administrative authorisations for the intended use and energy efficiency or, where regional law uses a prior communication or responsible declaration instead, proof that it was filed and that the waiting period has run with no blocking decision recorded in the Land Registry.
How the facility is repaid
Three exits are normal: sale of the finished units, refinancing onto a long term mortgage once the asset is income producing, or sale of the completed project to an investor. Each has to be evidenced rather than asserted. Presales with guaranteed deposits evidence the first. A term sheet, or at least a defensible view of what the asset will look like to a bank once stabilized, supports the second. An indication of appetite supports the third.
The most common failure is not the building. It is the gap between practical completion and the moment money actually arrives: licences of occupation, registration of the new construction, notarial completions, and buyers arranging their own mortgages. That gap is routinely underestimated by two or three months, and a facility whose term ends at completion rather than at completion plus that gap is a facility that will need extending on the lender’s terms.
Where the structure sits
Most international developers hold Spanish projects through a company, and often through a foreign parent. That structure has to be coherent with the financing: the borrower has to be the entity that owns the asset, guarantees have to come from entities with something to guarantee with, and intragroup funding has to be documented on terms that survive scrutiny. Where a Dutch or other European holding sits above the project, the interaction with intercompany loans and guarantees matters, because a lender reads a group’s internal arrangements as evidence of how it conducts itself.
On the Spanish side, two provisions of the Corporate Income Tax Law, Law 27/2014, carry most of the weight. Article 18 requires transactions between related persons or entities, as that article defines them, to be valued at market value, meaning the value independent parties would have agreed under arm’s length conditions. Article 16 limits the deduction of net financial expenses to 30 per cent of the operating profit of the year, allows net financial expenses of 1 million euros in any event, prorated where the tax period is shorter than a year, and lets the excess be deducted in later years within the same limit, with further rules and exclusions set out in the article itself. A shareholder loan priced without reference to the first or sized without regard to the second is the kind of weakness a lender’s tax due diligence looks for.
Montclare structures and arranges financing secured on European assets, and prepares the corporate and tax structure that sits behind it. Our services are set out on our services page.
This article is informational and does not constitute tax, legal or financial advice. Lending and credit intermediation are regulated activities and the treatment of any transaction depends on its facts. Each engagement is subject to scope and applicable regulation.