US development sources and uses: balancing construction funding

Define what the financing must cover

Split uses into acquisition, hard costs, soft costs, financing fees, interest and reserves. State which uses are eligible for the construction loan and which the sponsor must fund. The OCC’s commercial real-estate lending handbook discusses construction budgets, equity and loan administration; actual eligibility follows the loan documents.

A contingency allowance is part of the budget, not unrestricted cash already spent. An interest reserve is a funding allocation whose draw and release rules must be modelled.

Sources: Office of the Comptroller of the Currency: Commercial Real Estate Lending, version 2.0

Balance a fictional $20m budget

Assume $4m of land, $11m of hard costs, $3m of soft costs, $1m of interest and $1m of fees and other reserves. A $12m construction facility and $8m of sponsor equity cover the $20m total. No presale cash or mezzanine debt is assumed.

The $1m interest allowance is already included in uses and in the draw schedule below. Adding another $1m reserve to sources would overstate funding unless a matching separate use and real commitment existed.

Apply an equity-first draw rule

For this simplified example, all sponsor equity is contributed before loan draws, and all scheduled costs are eligible after that requirement is satisfied.

Test a funded commitment that cannot be drawn

Suppose $500,000 of quarter-two costs fails the lender’s eligibility test until quarter three. The facility still totals $12m, but the sponsor needs an additional $500,000 bridge at that point. Reimbursement later should reduce that bridge, not create an unexplained distribution.

Track undrawn commitment, eligible costs, certified amounts, retainage and unrestricted project cash separately. A draw request is not a receipt until the lender releases it.

Reconcile the schedule at each reporting date

Opening cash plus equity and debt receipts minus uses equals closing cash. Opening debt plus advances and any separately capitalised interest minus repayments equals closing debt. Define the treatment of interest so the same charge does not enter both advances and a second debt addition.

Present the base funding balance, the largest timing gap and outstanding draw conditions to the lender and investment committee. A balanced total is the first check, not the final liquidity conclusion.