Development funding: test drawable debt and peak equity against the programme

Read the project, the loan and the investor separately

Start with project receipts less project payments before financing. The lowest cumulative balance shows the funding gap on that basis. A loan then supplies part of that gap, but debt is money to repay, not project income. Finally, calculate equity contributions and distributions. These three views explain different things and should reconcile without sharing ambiguous labels such as cash required.

Define peak equity as the maximum cumulative contributions less distributions to the investor. If the model also reports cumulative contributions before distributions, label that separately. A project that returns cash and later calls for more capital can have a different peak net investment from its total cash contributed. Neither measure automatically includes a guarantee, undrawn commitment or another project supported by the same investor.

RICS distinguishes project cash flows from cash flows after financing and cautions that a particular borrowing structure can change the basis of the appraisal. Keep the project result and investor result visible separately when presenting a funding proposal.

Sources: RICS: Valuation of development property, Appendix B1.2.8

Separate committed debt from debt available to draw

Begin with the facility’s actual terms. Distinguish the amount committed, the amount drawn, the remaining commitment and the amount currently drawable. Eligibility of expenditure, valuation or cost limits, certification, borrower contributions and other draw conditions can constrain availability. Only apply conditions relevant to the facility; there is no universal draw formula.

For each material payment, identify the due date, funding source, evidence required for a draw and the expected interval between approval and cash arriving. Where certification follows expenditure, test whether the borrower must bridge that interval.

Treat capitalised interest explicitly. If interest consumes the facility, it can reduce the amount left for works. If the borrower must pay it, it belongs in the equity schedule. A line labelled “finance provided” can conceal that distinction.

Record maturity and the order in which cash pays costs, interest, principal and distributions. Do not let a balancing formula create borrowing that the agreement does not permit.

• Distinguish a limit on cumulative draws from a limit on outstanding principal.
• State whether interest is paid in cash, drawn from a reserve or added to debt.
• Keep fees, minimum cash and restricted receipts visible where they apply.
• Use the agreed interest periods and day-count basis, including any changes in rate.

Sources: Office of the Comptroller of the Currency: Commercial Real Estate Lending, version 2.0: interest reserves and borrower equity

Set the rules for a small funding example

Consider an invented development with costs of 12 million and receipts of 15 million in one currency. Time zero is acquisition, followed by four equal quarters. All movements occur at each period end; the schedule does not estimate higher cash requirements within a quarter. Costs include land and development expenditure. Tax, arrangement fees, reserves and cost overruns are excluded to isolate the funding mechanics.

The investor supplies the first 3 million of project costs. A non-revolving loan then funds eligible project costs up to 7 million of cumulative draws. It cannot fund interest, and repaid amounts cannot be redrawn. Any remaining shortfall requires equity. Available receipts pay current project costs and interest first, then repay debt; distributions occur only after those obligations are met.

Interest is 2% of opening principal each quarter, equivalent to an assumed nominal annual rate of 8% with quarterly periods. New end-of-quarter draws accrue interest from the next quarter. Interest is paid, not capitalised. These are chosen example rules, not proposed terms or a market benchmark.

Follow every draw and repayment

At time zero, equity pays 2 million. Quarter 1 needs 4 million: the remaining 1 million of initial equity is used first, followed by a 3 million debt draw. Quarter 2 uses the remaining 4 million loan capacity, but its 0.06 million interest bill requires additional equity. That small top-up is exactly what a simple 3 million equity allowance would miss.

Quarter 3 receipts of 3 million cover costs of 2 million and interest of 0.14 million, leaving 0.86 million to repay principal. Quarter 4 begins with debt of 6.14 million. Interest is therefore 0.1228 million. The final 12 million receipt repays the debt and leaves 5.7372 million for the investor.

Reconcile the three different capital numbers

Before financing, cumulative project cash reaches a low of minus 10 million at the end of Quarter 2. Peak debt is 7 million. Peak equity is 3.06 million, including the interest top-up. Adding peak debt and peak equity gives 10.06 million here because both peaks occur together and finance adds a cash cost. Peaks do not necessarily coincide in a more complex project.

Across the full schedule, receipts of 15 million plus equity of 3.06 million plus debt draws of 7 million equal total cash sources of 25.06 million. Uses are project costs of 12 million, interest of 0.3228 million, debt repayment of 7 million and distributions of 5.7372 million. Uses also equal 25.06 million.

The investor receives 5.7372 million after contributing 3.06 million, a surplus of 2.6772 million. That equals the project surplus of 3 million less interest of 0.3228 million. It is an undiscounted cash result. It does not describe the return earned per year or prove that the required capital is available.

Test a receipt delay, then test the facility response

Move the final receipt of 12 from quarter four to quarter five. First isolate the financing effect: keep costs and receipts otherwise unchanged and assume the lender permits the extension with no fee or change in draw terms. That permission is a scenario assumption, not a conclusion about a real lender.

The borrower must now fund quarter-four interest of 0.1228. Peak equity rises to 3.1828. A further 0.1228 of interest is paid from the quarter-five receipt, bringing total interest to 0.4456 and investor profit down to 2.5544.

The final distribution remains 5.7372, but comes one quarter later after a larger investor contribution. Its amount alone would conceal the increased cash commitment.

Now test the actual facility response. If the receipt moves beyond maturity and no extension is committed, a debt repayment, refinancing requirement or funding shortfall must remain visible. The model cannot treat an assumed extension as available cash. Separately test any additional holding costs, changed sales proceeds, covenants and fees relevant to the case.

Report when cash is needed and how it can be provided

Put the dates and constraints next to the headline peak. The minimum useful output is the largest equity requirement and when it occurs, the next cash call, the remaining drawable debt, and the exposure if a required receipt or draw moves.

Test the time resolution as well. A monthly model can miss a supplier payment due before a draw later in the same month. Around the tightest period, inspect the actual payment order or use a finer schedule.

Restricted cash requires separate treatment. Deposits, escrow balances and sale proceeds subject to release conditions should not automatically be available to pay unrelated project costs. Use the actual restrictions and release events for the assignment.

The review should identify the shortfall, its date and a specific response whose availability can be verified. An uncommitted refinancing or unspecified sponsor top-up remains an assumption.

Ask whether the investor can fund the modelled contributions on their actual dates. Record any amount already spent, cash still to be committed and unused contingency separately. Land contributed by an owner may meet a contractual equity test while providing no cash to pay a contractor. A nominal commitment and immediately available cash answer different questions.

Use the small schedule to check the reconciliation, then build the working case from the actual facility documents, payment programme, tax treatment and cash restrictions. The assumptions that determine funding availability need an owner and a supporting document.

The US OCC’s lending handbook discusses interest reserves and construction-loan administration from a banking-supervision perspective. It is supporting context, not a global contractual rule. The facility documents and applicable local requirements govern the assignment.