subsequently fund the project. A few of the basic
requirements include pricing, with either a fixed rate
or variable rate (cost plus). The latter option is less
desirable for borrowers but may be appropriate
under certain conditions. A specific completion date
should be clearly defined as well as how change orders
will be handled. Modifications that change the
scope of work and/or the amount of the contract
require lender involvement.
Advance holdbacks, also known as retainage, must
be clearly defined. Retainage is a certain dollar amount
of the total contract that is withheld from the contractor,
pending verification that the work has been completed according to owner specifications and local building
codes, and that all material invoices and subcontractors
have been paid. The retainage allows the borrower and
lender a degree of financial leverage over the contractor
and final completion of the project.
Building plans. Building plans are an architectural
representation of what a building will look like after
construction. They are used by builders and contractors
to construct buildings of all kinds. Building plans also
are useful when it comes to estimating project costs
and preparing budgets.
The lender should always obtain a full set of plans to
be held in their files until the project is complete. If a
contractor problem develops during the construction
process and the lender is forced to replace the builder,
the new contractor will need a complete set of building plans to move forward with the project.
Construction budget. The construction budget is
an estimate of the total money needed for a specific
building project. A budget is a comprehensive review of
the individual expense items and is normally tracked
using a detailed spreadsheet. A clear and concise budget
format will divide the data into easy-to-read divisions or
categories — such as separating soft costs (architect,
engineering, appraisal and developer fees) from hard
costs (land, materials and labor).
It’s also important to delineate the interest reserve,
which is the line item that pays interest expenses
during construction. Another category that deserves
separation is contingencies, which will cover unanticipated costs and overruns. The precise budget format
will depend on the individual preferences of the lender,
but it should ensure a precise understanding of the
project’s progress in relation to its associated expenses.
Skin in the game
Equity contribution. Construction lenders normally
require the borrower to make a downpayment — often
20 percent to 30 percent of the loan amount. The exact
amount will vary depending on the borrower/lender
relationship, loan amount or duration, project type or
In addition, if the borrower owns the land free and
clear, it may be used as the equity contribution for the
project. The amount of equity contributed to the project will have an influence on fees, the interest rate and
other terms and conditions of the loan.
The greater the contributed equity, the stronger the
negotiating position of the borrower. Maybe the most
important aspect about borrower equity is that it must be
put into the mix in advance of any loan disbursements.
Prepaid expenses. Periodically, a contractor will
get a head start on the project and may pay for certain
expense items in advance. In some cases, the contractor
will request credit toward their equity contribution.
This process is normally acceptable, but the lender will
require a detailed listing of all expenses supported by
paid invoices, or receipts for specific items and their
related costs. n
<< Navigate continued from Page 52 “The greater the contributed equity,
the stronger the negotiating position
of the borrower.”
At a Glance
Additional conditions and
areas typically covered in a
■ No material changes in borrowers’ financial
■ Borrower demonstration of legal standing.
■ Financial reporting.
■ No additional debt by borrower.
■ No change in management.
■ No mergers or sales (alienation clause).
Loan commitment. Once approved, transactions
of a certain size and complexity will be communicated to the borrower, in writing, in the form of a
detailed commitment letter. This communication is a
formal document stating the loan has been approved,
subject to various preconditions and/or contingencies
that must be met prior to closing and funding the loan.
The format will vary from lender to lender, but tends
to be lengthy and very detailed. Generally, the commitment letter is required to be signed by the borrower
within a relatively short time period, maybe 10 to 15 days,
and is frequently accompanied by the payment of a
Loan agreement. A construction-loan agreement is
a contract between a lender and a borrower, which
recites the crucial terms under which the loan is granted
— including the many promises the borrower makes
to the lender. This is generally a detailed document
and sets forth the many representations and warranties
that are required before the loan can be funded.
Primarily, the lender will want the borrower to promise
to complete the work in a timely manner, get necessary
permits, and comply with all laws and building codes.
The many funding requirements will, of course, vary
from lender to lender and project to project.
There are several fundamental elements, however,
Other contractual elements include:
■ A commitment of borrower equity.