Any real estate investor interested in development will need to become intimately familiar with a construction draw schedule and financing. These construction financing tools are much different than standard single-family or multifamily loans and can be a bit more complex, with many moving parts.
A construction draw schedule dictates at which milestone you'll receive a set amount of disbursement. It's therefore highly important you understand the ins and outs of the draw process, know what to expect and avoid, and understand the nuances of the points of draw.
What is a construction draw schedule?
Construction financing works on what is called "draws," which means at certain milestones in the process of development, a certain amount of funds will be made available. For instance, once a foundation is poured, a development could be considered 20% complete; therefore, a 20% draw of the total funding can be made by the developer from the lender.
As development progresses, these draws will continue, all the way up to 100%. At each draw, there are certain requirements, such as a draw inspection and proof of expenses.
What follows is a typical construction draw schedule. There can be dozens of points of draw, which can vary significantly depending on the development project (commercial versus residential versus industrial) and the lender.
- First draw request 20%: Lot cleared, sub-plumbing, and concrete poured.
- Second draw request 20%: Framing, roof, and windows.
- Third draw request 20%: Exterior, plumbing, electrical, and insulation.
- Fourth draw request 20%: Cabinets, counters, flooring, brickwork, and gutters.
- Fifth (final) draw request 20%: Trim, painting, appliances, inspection, and occupancy.
At each of these draws, the lender will look for proof of payment and conduct a draw inspection. The final construction draw schedule will be when an occupancy permit has been issued and the project is considered complete. The idea behind a construction schedule is that the lender reimburses the developer at each stage of the construction project.
According to Fannie Mae’s (OTCMKTS: FNMA) model construction loan, the construction schedule is broken down into seven separate stages.
First advance -- Stage 1: Closing
- Purchase of property
- Payoff lien(s) on property
- Closing costs
- Interest reserve
- Monthly payment reserve
Second advance -- Stage 2: Site prep and utility service
- Drilling and installation of well or water hookup
- Installation of private septic system or hookup to public sewer system
- Grading of property
- Install electric service
- Install gas service
- Excavation of basement
- Construction of foundation
- Driveways and walks
Third advance -- Stage 3: Framing utility hookup and enclosing
Fourth advance -- Stage 4: Interior
- Partition wall
- Painting (exterior)
- Weather strip
Fifth advance -- Stage 5: Exterior finish
- Wood trim
Sixth advance -- Stage 6: Interior finish and completion
Seventh advance -- Stage 7: Final
- Punch list items
There may be a construction holdback, sometimes in the range of 10%, which the bank will use as collateral if there are any unpaid contractors who come after you following completion of the construction project.
The bottom line
There are many benefits as well as challenges associated with a construction draw schedule. Here are two more aspects of the construction draw schedule to consider:
- Appraiser: At each draw stage, the lender will want the work to be verified. You'll want to make sure you have a good relationship with this professional to ensure a smooth construction draw schedule.
- Wording: This should be 100% clear to you and your contractors. Vague wording can lead to costly construction funding delays.
Real estate development can be a lucrative niche for investors, particularly when resale prices are elevated in most markets. Buying land and developing it yourself is a great way to build in your own equity, refinance, and then repeat. In this case, understanding the construction loan draw schedule is critical for investors who want to master this type of investing. Done poorly, this type of project can have serious consequences.