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A 4 percent contingency on 48 ground up units, who eats the overrun

Take a common equity position in a ground up multifamily deal on a portal. 48 units, wood frame over podium parking, total capitalization $11.2M. Hard costs come in at $165 a square foot, 24 month build, construction loan at 65% loan to cost with a 12 month interest reserve on a 24 month term. $165 a foot for podium construction reads as a 2021 number in most markets, and an interest reserve that covers only half the loan term is worth sitting with. If the build runs long, and builds run long, the reserve is exhausted and someone is writing checks for debt service out of pocket in month 13 with zero rental income coming in. Contingency is 4% of hard costs, about $310k. A conservative ground up underwrite generally wants 8%, and even at that level a soils report that comes back wetter than the borings suggested can absorb the whole amount without anything dramatic happening. Equity raise is $3.4M, minimum $25k. The offering says the sponsor provides a completion guaranty to the lender. Worth understanding is whether that guaranty does anything for an LP, or whether it just means the lender gets a finished building while the equity funds the finishing. And if there is an overrun beyond the guaranty, is that a capital call to the LPs or dilution. The 140 page document set usually has the answer buried in the completion guaranty and capital call sections, worth reading closely before committing.

gregpowell66 AC4BPRO 19

Answer

raj_mehta14 PF4BPRO 10

The completion guaranty runs to the lender rather than to you. It is a promise to the bank that the building gets finished and the loan gets repaid, and the sponsor entity or its principals are on the hook for that. It does help you indirectly, because a half built building with a defaulted construction loan is the way common equity goes to zero fastest. But you cannot enforce it, and the money spent honoring it is not a contribution to your equity unless the operating agreement says it is. The two clauses to find tonight will be in the additional capital contributions section: whether the manager can issue a mandatory call, and what the dilution formula is if you decline. A straight pro rata reduction is the mildest form. A penalty multiple, where the contributing members get credited 1.5x or 2x what they put in, is common. The harshest is conversion of the new money into a preferred position that sits ahead of everyone, and it is not rare. Also check whether the sponsor's overrun funding comes in as equity, as a member loan, or as a sponsor advance repaid off the top on sale. That single choice moves where your dollars sit in line. The interest reserve issue you flagged is real, and it usually shows up as a lender requirement to fund an extension reserve at month 18, which is fresh cash from somewhere. Ask who is contractually obligated to provide it.

raj_mehta14 PF4BPRO 10

3 replies

bmoreno23ActivePRO

Following this because I didn't know a completion guaranty could exist and not protect the investors. That reframes a lot of what I've been reading.

Girder, does the 140 pages include a construction budget by line, or just the summary total? I'd want to see the line items to have any opinion on $165.

bmoreno23ActivePRO

Rena Expert

The mechanics vellum described are the right ones to check. A few things to add on the numbers you posted.

A 12 month interest reserve on a 24 month construction loan is common when the pro forma assumes lease-up revenue covers debt service from the point of first certificate of occupancy. That assumption is doing most of the work. If the building delivers in phases and the first units come online in month 18, the reserve gap may be small. If it's a single delivery in month 24, the reserve runs out with no revenue behind it and the source of the shortfall has to be named somewhere in the documents. Find it before you fund.

On contingency, 4% of hard costs on ground-up is toward the lower end of what construction lenders typically require, and lenders often hold their own contingency line inside the loan budget separate from the sponsor's. Ask whether the $310k is the sponsor's contingency, the lender's, or the same money counted once. Ask also whether unused contingency can be reallocated to other budget lines mid-project and who approves that.

On the guaranty, whether a completion guaranty gives an LP any recourse depends on the specific document language and on state law, so that one needs an attorney reading your actual copy rather than a general answer.

The assumption that decides this investment is the delivery date relative to the reserve. Everything else you listed is a matter of degree. Confirm the loan terms and reserve sizing in writing with the sponsor, and ask for the lender's approved budget rather than the marketing budget.

Rena Expert

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