Development Underwriting and Waterfall Modeling

JW199619's picture
Rank: Monkey | 47

Hi all,

I'm hoping someone can help me with a development model I'm working on for a real estate modeling class I'm taking. Just have a few questions that are really frustrating me:

Hard costs are 90 MM. Soft costs are 10 MM. Project costs are 100MM in total. Project will be completed at 36 months. Sale will be at 60 months. Split is GP/LP 30%/70%

(1) There is short term debt of 75% at 6% yr, amortized over 5 years with an I/O period of 3 years. There is long term debt at 80% cost, at 5% yr, amortized over 30 years. Am I assuming correctly that the short term debt is the construction loan? If this is the case, we'd pay off the entirety of the construction loan WITH THE LONG TERM LOAN at the point of refinance, the end of month 36, correct?

(2) The long term debt is 80% of cost. Does this 80% cost mean 80% of the entire cost of project (100 MM)? If so, we'd pay the entirety of the original loan (75MM), and have 5MM remaining, so does this 5 MM go towards the cash flow back to investors for that month, month 36? Additionally, how does this refi play into the cash flows for my waterfall model? This part of the model is really confusing me.

Would really appreciate the help! This is my first time attempt at a development model and waterfalls.

Thanks

Comments (6)

Nov 28, 2018

To answer your first question.....the construction loan is paid off at the end on month 36 with the new loan starting in month 36. The $5 M should be considered proceeds from refinancing which should be treated as distributable cash flow to your investors. That $5 M is reducing the equity basis in the development deal.

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Nov 28, 2018
JW199619:

(1) There is short term debt of 75% at 6% yr, amortized over 5 years with an I/O period of 3 years. There is long term debt at 80% cost, at 5% yr, amortized over 30 years. Am I assuming correctly that the short term debt is the construction loan? If this is the case, we'd pay off the entirety of the construction loan WITH THE LONG TERM LOAN at the point of refinance, the end of month 36, correct?

Yes, it should be, and yes, that's what you do. @Texas CRE hit the nail on the head.

JW199619:

(2) The long term debt is 80% of cost. Does this 80% cost mean 80% of the entire cost of project (100 MM)? If so, we'd pay the entirety of the original loan (75MM), and have 5MM remaining, so does this 5 MM go towards the cash flow back to investors for that month, month 36? Additionally, how does this refi play into the cash flows for my waterfall model? This part of the model is really confusing me.

Would really appreciate the help! This is my first time attempt at a development model and waterfalls.

Thanks

Are you sure the long term debt is % of cost and not % of value? Either way, yes it usually goes back to investors (depending on how your equity agreement is structured).

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Nov 29, 2018
JW199619:

Project will be completed at 36 months.

(1) There is short term debt of 75% at 6% yr, amortized over 5 years with an I/O period of 3 years.

Basically amortization doesn't factor into the short term/construction loan as long as you are drawing down your long term/investment finance on point of completion.

As asked above, are you sure long term loan is not 80% of value instead of cost? Because if it was 80% of cost my guess is (if you straight line the draw-down/costs) you wouldn't be able to fully pay off your short term loan due to interest cost.

But yeh, if your refi is higher than your outstanding loan/interest/fees then the surplus would be distributed to investors. As stated above the distribution would depend on your agreement.

Dec 3, 2018

More than likely here's how the WF would work...When you refi @ 80% of cost, yes the immediate proceeds go towards paying down the remaining principal of the loan. It wouldn't be the full amount since you would be amortizing by that point. There SHOULD be left over cash flow. This amount will then be run through the waterfall per the hurdles in the agreement. More often than not, it is enough to fully catch up any accrued and unpaid pref, and if you're lucky, return capital and maybe start promoting to the developer. However, it is usually just a way to pay down the pref balance and return some equity to the investors.

What should also be a key discussion point is how you are going to crystallize this deal. my guess is when it was originally underwritten, a short term construction loan operating agreement/JV is based on a 3-5yr hold...and therefore the hurdles and pref rates are geared towards such a deal. IF you are now talking a long term hold, the operating agreement would likely be restructured. Said differently, if the investors new at the deal closing it would be a long term investment, the operating agreement and terms likely would have been different. Therefore it becomes a negotiating game of giving the developer enough of a promote to get them a taste while allowing the majority investor to have enough ongoing cash flow to hold the deal long term. With interest rates trending upward, many new development deals are looking to lock in refinance rates and therefore exercise this "crystallization" scenario described herein. Sorry for the rant - typing as I'm thinking here...

Dec 3, 2018

Do you mean that your short term loan is 5 yr term and not 5 yr amo? 5 yr amo would be insane.

Dec 3, 2018
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