Borrower beware! Construction loans are a critical part of many real estate investments, but they can really get you! This is especially true around construction drawdowns, a standard part of these loans. For anyone involved in a project with a construction component, we discuss the top 5 things to know about construction drawdowns that can keep real estate investors up at night, and keep your project from making money.
To start with, construction drawdowns refer to the process of releasing funds from a construction loan to the real estate investor, builder or developer in stages as the work progresses. This allows the lender to monitor the progress of the construction and ensure that the funds are being used as intended. Drawdowns typically occur at specific milestones in the construction process, such as after the foundation is laid or after certain phases of the work are completed.
Now, construction drawdowns can be quite complex. Let’s DIG into the top 5 things to know about construction drawdowns that can really help or harm your project as a real estate investor or builder:
- Timing: This sounds simple, but money is like oxygen to a construction project – and you need to make sure to keep your oxygen flowing. The timing of drawdowns can be critical to the success of a construction project. If funds are not released in a timely manner, it can cause delays and increase costs. On the other hand, releasing funds too early can lead to problems if the work is not completed as planned.
- Cost of Interest calculation: And this oxygen line is prone to leaking – you can actually lose money if you miscalculate your interest, and find yourself paying more to your lender than you had planned. Construction drawdowns are typically based on a line of credit, which means that interest is charged on the outstanding balance. This can make it more difficult to budget for and manage the costs of a construction project, as the interest charges can change over time.
- Documentation and Compliance: We know – you’re already yawning. However, construction drawdowns are often subject to strict compliance requirements. Lenders may require extensive documentation and inspections to ensure that the work is being done correctly and that the funds are being used as intended.
- Risk management: Construction drawdowns can be used as a risk management tool by lenders – and risk management for lenders can translate into risky headaches for borrowers. By releasing funds in stages, lenders can limit their exposure to the risk of default or other financial losses. However, this can also make it more difficult for you, the real estate investor, builder or developer, to access the funds you need to complete the project.
- Dispute resolution: Fights are only fun in hockey, not in your business. Disputes between builders, developers, and lenders can arise during the construction drawdown process. These disputes can be difficult to resolve and can cause delays and additional costs for all parties involved.
So – borrower beware, and make sure to structure your loan with these top 5 things to know about construction drawdowns in mind. Then, make sure to keep your project on a tight schedule and keep accurate records. Despite the complexity of construction drawdowns, if you stay on course, you should have no issues getting your money, which helps you… make money.
Diggifi is the first and only digital marketplace for real estate investors to access competitive financing for any project, and it’s all done via an app. Check out Diggifi at www.diggifi.com or download the app here or here.