Questions regarding modeling development project & construction loan
I am practicing modeling and trying to build a model for a construction project. For this hypothetical project, I will build an apartment building (2 years), lease it up (1 year), and sell it immediately after the lease-up (and repay the construction loan).
My question 1: During the lease-up, does positive cash flow from the property go towards paying off the construction loan? If the property generates negative cash flow, do I need to draw more construction loan?
My question 2: If I decide to hold the property for 5 years after the lease-up, should the refinancing to a permanent loan occur after the construction or the lease-up phase?
Thanks for your help.
G
It can, but doesn’t have to. Depends on what you are instructed to do, but for simplicity, most case studies will tell you to assume that it pays down the loan. It’s also another layer to model out, so good practice. During lease up you will definitely have negative operating cash flows, so usually what you do is model everything out and ignore the negative cash flows and then at the end add an operating reserves line item (the sum of your negative cash flows) as part of your budget.
The refi will occur after lease up (at stabilization) and this goes for modeling a case study and in reality. In reality, it is unlikely for anyone to give you a permanent loan without first meeting 1.20-1.25 DSCR and other debt yield metrics that require stabilization to meet
Appreciate it. Helped a lot!
Your loan and/or org docs will state with what happens with positive cash flow, but as Fred said you're not going to be hitting positive cash flow until near the end of lease up. In a merchant build scenario specifically, the positive cash flow is almost irrelevant outside of a modeling perspective, because the assumption is it goes out to market at 80% leased and is sold at 90%. If done properly, the amount of months the property is actually making money for you is incredibly small. The only time I've made distributions in my career are when something goes poorly and we have to hold for another year.
As far as what to do with the property when it is generating negative cash flow, that is factored into the model, and thus, the construction loan itself. That's one of the reasons banks are happy to give you 3-4 years interest only loans, because they're also loaning you the money to pay the interest for 2-3 years until you're cash flow positive, and you're paying interest on those interest payments. Once a month, you draw for the interest payment from the bank just like you would draw to pay your architect or GC.
As Fred said, after the lease up phase due to debt yield calculations, but the other factor here is the interest only period and how the interest rate and payment post-refinancing compare to your existing debt service. If you get a 4 year interest only loan, and it takes 2 years to build the deal and 1 year to lease it up, more likely than not you're going to ride out that final year of I/O debt unless putting permanent money on the property makes more financial sense.
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