In ground up construction and renovation projects there lies a component that can make or break the project: the budget. If you overspend on fixtures, flooring and other design details, you risk making less profit, or worse, losing money. When financing these projects, it’s imperative to have a solid comprehension of the use of funding draws, including successfully submitting draw requests to keep the construction or renovation work on track and on budget. In this article, we’ll walk you through what a draw request is and how they work in real estate projects.
What are Draw Requests?
Draw requests are formal procedures used to access funds from a construction loan as the building work progresses. Instead of disbursing the entire loan amount immediately upon approval, funds are released in stages that correspond to the completion of specific construction milestones decided in your construction budget prior to loan approval.
The borrower or their contractor submits draw requests to the lender, who reviews the request and conducts a property inspection to verify the completion of the work before releasing the corresponding funds. This system ensures accessibility of funds, tracks construction progress, ensures proper fund usage, and facilitates the early detection of any project delays
Mechanism of Draw Requests
Before construction begins, the borrower and contractor present a draw schedule to the lender. This schedule includes an estimate of the work to be performed and the associated costs, serving as the foundation for subsequent draw requests.
Once a portion of the work is completed, the borrower or contractor submits a draw request to the lender, providing details of the completed work and corresponding costs. The lender inspects the property and releases the funds if the work is satisfactory and aligns with the original draw schedule.
Importance of Adhering to the Original Budget
Adhering to the original budget is crucial for managing a construction project, whether it involves building a new home or executing a fix-and-flip. This adherence ensures proper fund allocation and maintains the project’s trajectory, avoiding unnecessary delays or stalls.
Investors who submit draw requests exceeding the original budget risk the need for lender approval or potentially re-underwriting the loan, both of which can cause significant delays. Therefore, diligent budget management and meticulous expense tracking are paramount.
Effective Budget Management for Real Estate Investors
- Detailed Budget Plan: Begin with a comprehensive budget plan that outlines all expected costs, including materials, labor, permits, inspections, and contingency expenses. This plan forms the basis of your construction loan and subsequent draw requests.
- Regular Budget Reviews: Monitor your budget regularly, comparing actual costs against projected expenses. This ongoing review helps identify areas of overspending and allows for necessary adjustments.
- Change Order Management: Changes to the original construction plan are common. However, all change orders should be thoroughly reviewed for their impact on the budget. Significant changes need to be promptly communicated to the lender.
- Contingency Fund: Unforeseen costs are typical in construction projects. Including a contingency fund in your budget (typically 10-20% of total costs) provides a financial cushion for these unexpected expenses.
- Expense Tracking Software: Make use of expense tracking software to monitor and categorize expenses. This software can synchronize with bank accounts and credit cards, providing real-time updates and instant overviews of spending.
- Document Management: Keep all receipts, invoices, contracts, and change orders organized and easily accessible. Digital document management solutions can be useful for this purpose.
- Regular Audits: Conduct regular audits of your expenses to ensure alignment with the budget. Investigate any discrepancies or unexpected costs.
- Professional Assistance: Consider hiring a construction accountant or financial advisor specializing in real estate to provide expert guidance on budget management and expense tracking.
By adhering to the budget and implementing robust expense tracking systems, real estate investors can minimize financial risks, streamline the draw request process, and ensure successful and profitable completion of their construction projects.
Construction loans typically allow for multiple draws, usually ranging from three to six, depending on the percentage of work completed. The exact number of draws required should be determined based on the construction budget and timeline. It’s important to note that additional draws may incur processing and inspection fees, as well as increased loan balance interest charges.
Managing Construction Budget Modifications
Any changes to the construction budget should be promptly communicated to the lender to ensure project feasibility and loan suitability. This transparency helps prevent complications or misunderstandings that could derail the project. Significant changes may include unforeseen expenses, scope alterations, or increased labor costs, which may require lender approval before proceeding.
Procedure for Requesting Changes
If changes to the construction budget are necessary, the lender should be notified promptly. Detailed explanations of the changes and an updated cost estimate are required, and additional documentation, such as revised plans or contractor contracts, may also be necessary. The lender will then evaluate the changes and, in some cases, may need to re-underwrite the loan.
Property Inspection Process
Upon submission of a draw request, the lender carries out a property inspection to verify the completion and quality of the work. This process involves an independent inspector visiting the site and comparing the completed work to the original plans and budget. The inspector checks for any issues or discrepancies and sends a report back to the lender.
Draw Request Processing Time
Typically, processing and payment of draw requests take 3-5 business days, assuming no issues arise. To avoid problems, it’s important to follow the original budget, submit all necessary documentation, and promptly inform the lender of any changes or issues. Scheduling property inspections in a timely manner can also prevent processing delays. Unresolved issues or discrepancies may prolong the processing and payment of your draw request.
Understanding the draw request process is fundamental when securing a construction loan. At LYNK Capital, we specialize in construction and renovation loans and take care to guide our borrowers through the intricacies of draw requests. Our expertise ensures that you receive the necessary funds when needed, minimizing errors and maximizing efficiency.
With our professional assistance, you can smoothly navigate the draw request process, allowing you to focus more on the construction at hand.