From the desk:Real Estate Crowdfunding (Investor)

A 4% contingency on 48 ground-up units. Who eats the overrun?

Common equity 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.

I've built things. $165 a foot for podium construction is a 2021 number in most places I've worked, and the interest reserve covering half the loan term is the other thing sitting wrong with me. 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. In my own work I don't start a ground-up without 8% and I've spent all of it on a project where nothing dramatic happened, just a soils report that came back wetter than the borings suggested.

Equity raise is $3.4M, minimum $25k. The offering says the sponsor provides a completion guaranty to the lender. What I want to understand is whether that guaranty does anything for me as an LP, or whether it just means the lender gets a finished building and my equity is what funded the finishing. And if there's an overrun beyond the guaranty, is that a capital call to me or dilution.

Haven't found the answer in the summary. Docs are 140 pages and I'm going through them tonight.

Answer

2raj_mehta14CapitalPRO6

The completion guaranty runs to the lender, not to you. It's 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 can't enforce it and the money spent honoring it isn't a contribution to your equity unless the operating agreement says it is.

The two clauses to find tonight, and they'll be in the additional capital contributions section: whether the manager can issue a mandatory call, and what the dilution formula is if you decline. Common ones are a straight pro rata reduction, a penalty multiple where the contributing members get credited 1.5x or 2x what they put in, and conversion of the new money into a preferred position that sits ahead of everyone. The third one is the harshest and it's 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 thing 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's contractually obligated to provide it.

3 replies

1bmoreno23AB1B

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.

0Rena 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.