MANAGING YOUR CONSTRUCTION FINANCES
After you have assembled your financing and before construction work begins in earnest, you will close on your construction financing, also known as the “initial closing.” Construction financing closing may happen concurrently or after the pre-construction conference, so long as it occurs before the start of construction.
When you close on construction financing, the following will happen:
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You can receive your first payment from your construction loan.
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You will pay your initial financing fees unless an extension or deferment has been granted.
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You and your lender will conduct a final review of all forms and exhibits to ensure accuracy of the terms.
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You and your lender will confirm their loan constitutes a first-priority lien on the property.
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You and your lender will confirm necessary steps have been taken to secure the property and prepare for construction, including confirming zoning compliance, building permits, utility services, and insurance coverage.
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Final copies of the funding agreement(s) and associated documentation will be circulated to all parties of the agreement(s) for their records.
Draw-downs, draws, or progress payments are amounts of your construction loan that you can access at various points to pay contractors. You will set your draw schedule with your lender. The schedule may be divided in equal amounts over set intervals (e.g., monthly payments) or it may be tied to completion of specific milestones (e.g., once those construction milestones are reached and confirmed via inspection by the lender, you will receive payment).
You or your GC may choose to retain a portion of the progress payment until the contracted work is complete to ensure it is completed on time and to your quality standards. This practice is known as “retainage.” Even with retainage, it is important to have clear, shared expectations with your contractor for how and when the work will be done to avoid cash flow issues or delays. Check your funding terms for details on any retainage regulations that may apply.
Contractors will submit invoices to you for their portions of the project, which you will review against your construction budget to monitor any potential cost overruns. This will allow you to track construction progress relative to budget spenddown. Set invoicing schedules with your contractors, such as requiring a monthly invoice submission, to assist with this process. Before each scheduled draw, you will submit a progress payment request and supporting documentation, such as contractor invoices, to trigger payment from the lender. Some lenders will require an inspection at the time of the draw request or milestone to confirm work completed.
Thorough documentation of contracts, invoices, and payments will be critical for your lenders and project funders and may be necessary for tax purposes, disputes, or legal matters. Document project communications well, making sure you have dated notes as records of decisions, particularly those with financial implications, even if they are by phone or in-person.
Funders may require regular updates during the construction process to ensure satisfactory progress and compliance with funding terms. They will confirm your actual progress reflects your application projections and their funding is being used for eligible purposes (per the funding agreement).
Change orders are documentation of any changes to a contractor’s scope of work to which you agree. The change order should include details of the changes being made plus any cost or timeline implications and should be signed by both you and the contractor once approved. The change order process should be specified in your contracts and discussed at the predevelopment conference. When reviewing change orders, determine if costs incurred exceed your contingency budget or if they can be offset elsewhere. You also must ensure changes comply with existing funding terms and do not jeopardize any of your funding.
MARKETING AND LEASE-UP
Before construction is complete, begin finding prospective tenants or homebuyers who will occupy your development. Do not wait until construction is finished because that will extend the length of your “lease-up” or sales period when your building is habitable but not occupied/fully occupied and will delay your closing. The longer you remain in construction financing, the lower the profitability and can impact your ability to repay financing.
As a developer, the faster your project starts generating income, the better. Real estate finances are impacted by the time value of money, because inflation, risk, and opportunity costs (other things you could use the money for) all increase over time. This is the reason we discount projected future cash flows when calculating expected rates of return (see Financial Modeling Tool and Guidance).
Some funding sources may also place restrictions on how quickly rental units should be leased. Developments supported with Housing Tax Credits are generally required to lease units within 90 to 120 days after the Certificate of Occupancy is issued. This leasing requirement is usually tied to the syndicator’s market absorption estimate, which determines the timing of equity payments.
Any time you are representing your development to the public is a chance to market it and its benefits to the community, including the concept stage through project completion. Targeted marketing to attract prospective tenants or homebuyers should begin in earnest six months prior to construction completion. You can choose to hire a marketing contractor to support or lead this work. If you contract out for property management services or hire property management staff, they will be responsible for marketing and lease-up. Even if you have a marketing or property management contractor, you should provide oversight to ensure that outreach, marketing, and tenant selection or homebuyer underwriting all comply with local, state, and federal laws, plus any funding terms governing the project.
Some funding sources may require you to create a marketing and outreach plan and, even if it is not required, this kind of planning document is useful for ensuring alignment between your marketing activities and your project goals and requirements.
OBTAINING YOUR CERTIFICATE OF OCCUPANCY
A Certificate of Occupancy is issued by local building officials, certifying that your property is up to building code and safe for people to live in. The building department will likely have a specific process for these inspections and may require certain documentation before you can schedule the inspection to obtain your Certificate of Occupancy. Throughout the construction process, you should work proactively with the local building department to understand their processes and build a strong working relationship. Prior to the Certificate of Occupancy inspection, you should have conducted a final inspection and worked with the construction team to address any items on the developer’s punch list.
Ideally, you will have identified any potential code violations during previous inspections and your building inspector will be able to issue a Certificate of Occupancy after the last inspection. If minor violations are identified, you may be able to address them on the spot; otherwise, you will need to schedule a follow-up inspection, which could add weeks to your lease-up period. A Temporary Certificate of Occupancy (TCO) may also be issued for a portion of your development, if there is a matter that cannot be quickly resolved and you need to start lease-up before the final Certificate of Occupancy can be issued.
After you have the Certificate of Occupancy and the development reaches stabilized occupancy, you can move forward with closing on the permanent financing. Lenders will differ on their definition of stabilized occupancy. Generally, it is a minimum percentage occupied for a certain number of days. Closing on permanent financing will include a review and verification of previous financing assumptions to ensure they are still accurate and sufficient to minimize lender risk. Information from the final round of inspections will be used to prepare a forecasted capital expenditure budget, which estimates the timing and cost of future repairs and system replacements. This will be used during closing on the permanent financing to ensure the replacement reserves are adequate for the expected needs.