If you have dealt with any of those God-awful complex multi-tab real estate development feasibility and cashflow modeling templates on Excel, you might be intimidated and confused about some simple concepts. In this piece, we are explaining construction draws. Let’s break-it down to its basic building blocks using a simple example.
Work-in-place
Construction draws are the funds the bank pays the builder during the course of construction. Typically, the bank pays for the performance. The bank wants to make sure that their capital is paying for work-in-place and only after you put in your share. The performance is measured by the percentage of the work completed. To determine the percentage complete, the bank sends its appraiser to provide a report detailing what percentage of the work is completed.
Loan-to-value (LTV)
The other factor the bank considers is the loan-to-value (LTV) or loan-to-cost (LTC) ratio. This is the total loan amount over the total cost. You can find the LTV and LTC in your term sheet. The bank is obligated to pay for the completed work to the maximum of total approved amount times the percentage complete. In other words, if the total approved loan amount is $10M and the project cost is $5,500,000 when the project is deemed to be 50% complete, the applicant has to pay the difference of $500,000 over-budget amount.
Total Loan Amount
Let's see how this concept looks like in practice. First, let's establish the basic assumptions about this fictitious project financing. Assume that the LTV for this interest-only construction loan is 80%, meaning that the bank pays for 80% of the project value. And, the total project cost is assumed to be $5,000,000. Given the LTV of 80%, the bank's total loan amount is capped at $4,000,000.
Bank Total Loan Amount = LTV x Project Cost
Bank Total Loan Amount = 80% x 5,000,000 = $4,000,000
This means that the builder has to supply the first $1,000,000.
Draw Sheet
For a progress draw, a draw sheet is usually prepared that shows the total value of the completed work-in-place. Let’s say this total work-in-place value (W.I.P.) as of the date of draw sheet is $2,000,000. Given that the builder already paid its share of $1,000,000, the bank supplies the additional $1,000,000. Now, there is $3,000,000 from the bank’s construction loan. And, if the project is not overbudget, there is exactly $3,000,000 required to complete the work (otherwise known as cost-to-complete or C.T.C.)
To better illustrata this, let's look at an example of a fixtitious construction draw sheet. The column W.I.P. stands for work-in-place and C.T.C stands for cost-to-complete
As you can see, original budget, revised budget, work-in-place, and cost-to-complete for each budget heading is provided. There are a few noteworthy equations hidden in this.
First, note that the total approved financing is equal to total budget cost less the total equity. Also, notice that the total approved financing, $12,432,731 less the total work-in-place of $2,528,489 is equal to the total remaining fiancing amount.
As you see, the concept is not that complicated. To simplify other parts of your real estate development work, subscribe to our channels on YouTube, Instagram, Twitter, and our mailing list below. Subscribers will receive priority access to our deals.