Staged Funding
Staged funding is a financing method where a lender disburses loan proceeds incrementally as a real estate project progresses, rather than providing the full amount upfront. This approach is common in construction and rehabilitation projects.
Key Takeaways
- Staged funding disburses loan capital in phases, tied to project milestones, reducing risk for both borrower and lender.
- It is predominantly used for construction, fix-and-flip, and significant renovation projects where costs are incurred over time.
- Each disbursement, or 'draw,' typically requires an inspection and approval of completed work by the lender or a third-party.
- Key benefits include reduced interest payments on unused funds and enhanced financial oversight, while risks involve potential delays and disputes over draw approvals.
- Understanding the draw schedule, inspection process, and potential holdbacks is crucial for effective project management and cash flow.
What is Staged Funding?
Staged funding, also known as construction draws or progress payments, is a financing mechanism where a lender provides capital in a series of disbursements rather than a single lump sum. These disbursements are typically tied to specific milestones or completion percentages of a real estate development or rehabilitation project. This method is prevalent in projects like new construction, fix-and-flips, and major renovations, where the total project cost is substantial and expenses are incurred over an extended period. The primary goal is to align the release of funds with the actual progress of the work, thereby mitigating risk for both the lender and the borrower.
How Staged Funding Works
At the outset of a project, the borrower and lender agree upon a detailed draw schedule, which outlines the specific stages of work and the corresponding percentage or amount of the loan that will be released at each stage. This schedule is often based on the project's budget and timeline. As the project progresses, the borrower requests a 'draw' from the lender. Before releasing funds, the lender typically sends an inspector or appraiser to verify that the work corresponding to that stage has been completed satisfactorily and that the property's value supports the requested funds. This verification process ensures that the loan funds are used for their intended purpose and that the collateral (the property) maintains sufficient value relative to the outstanding loan balance.
Key Components of Staged Funding
- Draw Schedule: A pre-determined plan detailing the timing and amount of each loan disbursement, linked to project milestones (e.g., foundation complete, framing complete, roof on, drywall, finish work).
- Inspections: Third-party inspections or lender site visits are conducted before each draw to confirm the completion and quality of work, ensuring compliance with the project plan and budget.
- Lien Waivers: Borrowers are often required to provide lien waivers from contractors and subcontractors, confirming they have been paid for previous work and will not place a lien on the property.
- Holdbacks: Lenders may retain a small percentage of each draw (e.g., 5-10%) until the entire project is completed and final inspections are passed, ensuring all work is finished to standard.
The Staged Funding Process for Investors
Navigating staged funding requires careful planning and execution. Here's a typical step-by-step process for real estate investors:
- Secure Financing: Obtain a construction loan or rehab loan from a lender specializing in staged funding. This involves submitting detailed project plans, budgets, and a proposed draw schedule.
- Initial Draw: Receive an initial disbursement, often covering the property purchase and initial soft costs or demolition. This may be a smaller percentage of the total loan.
- Execute Work & Request Draw: Complete a defined phase of work according to the draw schedule. Once a milestone is reached, submit a draw request to the lender, often including invoices and proof of payment to contractors.
- Lender Inspection & Approval: The lender arranges for an inspection to verify the completed work. Upon satisfactory inspection and review of documentation, the lender approves the draw.
- Funds Disbursement: The approved funds are disbursed to the borrower, typically via wire transfer, allowing them to pay contractors and suppliers for the completed work.
- Repeat & Final Draw: This process repeats for each subsequent stage until the project is complete. The final draw is typically released after all work is finished, final inspections are passed, and all necessary lien waivers are submitted.
Real-World Example: A Fix-and-Flip Project
An investor, Sarah, purchases a distressed property for $200,000 with a planned renovation budget of $100,000. She secures a hard money loan for 70% of the After Repair Value (ARV), which is estimated at $400,000. The loan amount is $280,000 (70% of $400,000), structured with staged funding. The lender requires a 20% down payment on the purchase price, so Sarah brings $40,000 to closing. The remaining $240,000 of the loan is disbursed in stages.
Draw Schedule Example:
- Initial Draw (Purchase & Demolition): $160,000 (to complete the $200,000 purchase after Sarah's $40,000 down payment) + $10,000 for initial demolition. Total: $170,000.
- Draw 1 (Framing & Rough-ins): After demolition and structural repairs are 100% complete, and rough plumbing/electrical are 50% complete, Sarah requests $30,000. An inspector verifies the work.
- Draw 2 (Drywall & Flooring Prep): Once rough-ins are 100% complete and drywall is hung, Sarah requests $25,000. Another inspection confirms progress.
- Draw 3 (Finishes & Fixtures): With flooring installed, cabinets in, and painting underway, Sarah requests $15,000.
- Final Draw (Punch List & Landscaping): After all work is complete, final cleaning, and minor landscaping, Sarah requests the remaining $10,000 (assuming no holdbacks or all holdbacks released). Total rehab draws: $10,000 + $30,000 + $25,000 + $15,000 + $10,000 = $90,000. The remaining $10,000 of the $100,000 rehab budget would have been covered by Sarah's initial cash or a contingency fund.
This structured approach ensures Sarah only pays interest on the funds she has received, and the lender's risk is minimized as funds are released only when value has been added to the property.
Frequently Asked Questions
What types of real estate projects commonly use staged funding?
Staged funding is most commonly used for projects with significant construction or renovation components. This includes new residential or commercial construction, fix-and-flip projects, major property rehabilitation, and large-scale development projects. It's less common for simple buy-and-hold purchases without substantial renovation, as those typically involve a single, upfront loan disbursement.
What are the main benefits of staged funding for investors?
The primary benefits for investors include reduced interest costs, as interest is only paid on the disbursed funds, not the entire loan amount. It also provides a structured approach to project management, encouraging adherence to budgets and timelines. Furthermore, the lender's oversight through inspections can act as an additional layer of quality control, ensuring work is completed to standard before payments are made.
What are the potential risks or challenges associated with staged funding?
Challenges can include delays in receiving funds if inspections are slow or if there are disputes over completed work, which can impact project timelines and contractor payments. Investors must also manage cash flow carefully to cover expenses between draws. Additionally, unexpected project changes or cost overruns can complicate the draw schedule and may require renegotiating with the lender or finding alternative funding.
How long does it typically take to receive funds after a draw request?
The timeframe for receiving funds after a draw request can vary significantly depending on the lender and the complexity of the project. Generally, it can take anywhere from 3 to 10 business days. This period includes the time for the lender to schedule and conduct an inspection, review all submitted documentation (like invoices and lien waivers), and process the disbursement. It's crucial for investors to understand their lender's specific turnaround times and factor this into their project scheduling and cash flow management.
Are there different types of lenders that offer staged funding?
Yes, various types of lenders offer staged funding. These typically include hard money lenders, private lenders, and some commercial banks or credit unions that specialize in construction or rehab loans. Hard money lenders are often preferred by investors for fix-and-flip projects due to their speed and flexibility, though they typically come with higher interest rates. Traditional banks may offer more competitive rates but often have stricter underwriting criteria and longer approval processes.