CRE Dev Model - How do you account for an improved existing structure &amp; how do you pay off a construction loan?
Hi all! 

*TLDR; if you can help with either scenarios, please drop a comment with an answer or any additional info that must be considered.* 

I am  trying to wrap my head around modeling a dev project. I understand the conventional model of ground up development (i.e.  acquiring, developing, and selling)...BUT not when the strategy is a less straightforward. There are two different areas that I am curious about and because my questions are so nuanced, i created simple examples to illustrate what I am trying to understand:

**1st scenario**

\- A parcel has 3 structures. i want to demolish 2 structures, and build upon the remaining structure that is already existing. This means that i will need to estimate for demolition cost for the two structures and estimate for building on top of something that already exists. Lets say the remaining structure is 10K and i am planning to build 60K.

1. If its 120 PBSF , do i apply it to 50K (60K-10K) ? Also do i  have to apply a fraction of the PBSF to the already existing 10K because it will probably be retrofitted for the new use?  
2. how do you back into a demolition cost?

**2nd scenario** 

**-** when getting a construction loans you have to burn all your equity till you start pulling money out from your draw. Once you burn all your money in the draw, you have to pay back the loan. I've seen models where you pay off the model by selling condos or selling the property,but what if you want to refinance to a perm loan? Let's say you the cost of construction is $10mm. You put up $3.5mm. You burn through the $3.5mm halfway through your project so you start drawing from the $6.5mm. As you use the $6.5mm, you are only paying interest but once the loan is up, you have to pay the entire $6.5mm back. 

1. what if your perm loan is not large enough to pay for the $6.5mm? Is it just a bad investment?
2. Is the construction loan just paid off in one lump sum all the time?
3. is the interest on your construction loan paid with the equity and draws?

&amp;#x200B;

Any help or color to these scenarios would be much appreciated!!
[{"id": "f6qx2b8", "text": "2nd scenario: \n\n1. The perm loan will be based on As-Is LTV, which should include your return. \n\n2. Construction loans are always paid off in lump sums  to perfect the lien interest until construction is complete. Most construction loans include a lease up period, so some loans will be paid off during this period. \n\n3. Yes", "replies": [{"id": "f6qzbmd", "text": "First and foremost  thank you for answering. super helpful... but i have a follow up on answer #1\n\n1. So if your Perm LTV is 80%, 80% of the value of your finished project should nominally be greater than or equal to your construction LTC ? (65% of construction cost in my example)....also What do you mean it should include your return? is there a spread between the perm Loan amount and construction balance that you can usually take as a return?", "replies": [{"id": "f6r08kp", "text": "Perm loans are usually based on the lesser of DSCR or LTV. I rarely see a perm loan at 80% LTV with a healthy debt coverage.", "replies": [{"id": "f6r0ig4", "text": "Thank you!", "replies": [{"id": "f6rgxit", "text": "You should have a delta between the Stabilized LTV and the construction cost, even with interest carry. \n\nMost construction loans carry the interest until the end of the term \u2014 you aren\u2019t paying interest as you go, you pay it off at take out. \n\nIf your property isn\u2019t worth more than what you built it for, you over paid to build it. \n\nEvaluate your construction cost. \n\nEvaluate your y1 proforma value \u2014 project NOI against a comp cap rate.\n\nYou\u2019ll likely refi the lower of 75% LTV or 1.25 DSCR.", "replies": [{"id": "f6t4ivq", "text": "This is great. Thanks! i think imma end up referring to this comment many times in the near future lol", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "f6rj5mt", "text": "I finance projects all the time in which my loan proceeds are used to pay off the construction loan and return a portion of equity. A project that you\u2019re describing will usually complete without being ready for a full perm loan (not stabilized), so will need a bridge deal. I do those too. They\u2019re often structured as short term floaters with prepay flex, future findings for leasing/capex costs and sometimes a capitalized interest reserve. Construction loan might be L+ 500 with full recourse, bridge loan L+250, no recourse and perm loan at L+150 (floater) or T+125 (fixed). If your perm loan can\u2019t be sized to a ~7-8% debt yield to pay off your construction loan, then your deal is busted and probably needs more equity.", "replies": [{"id": "f6rk08c", "text": "What happens if a developer builds 20 condo units and can't sell them all?", "replies": [{"id": "f6rkc3s", "text": "He\u2019s Fubar. Typically the last few units are where all the profit is.", "replies": [{"id": "f6rkvwv", "text": "What does the lender do?  My partner got lucky by dropping prices and now he holds the last unit mortgage free but it's not selling.  We were going to do a development together next year, but now I'm not sure it is worth the risk of losing everything.", "replies": [{"id": "f6rkz5d", "text": "Well if the lender gets paid off, nothing. The lender will get paid first from sales, only once fully repaid will the developer get to keep any sales proceeds. If the sales aren\u2019t enough to pay off the loan, then the developer will have to come out of pocket to pay it off.\n\nThere were countless busted condo deals like this coming out of the downturn. Most projects were sold at a steep discount after lenders foreclosed and buyers turned them into apartments for rent", "replies": [{"id": "f6rl2u8", "text": "Thanks.  What is a good test to determine whether to proceed with a development?", "replies": [{"id": "f6rmf5d", "text": "For sale - target 20% margin, including healthy contingency. For rent - 100 bps spread to market cap rates.", "replies": [{"id": "f6v25es", "text": "Thanks", "replies": [], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "f6um5en", "text": "Construction loans for condos will have a designated release price per unit that is, for example, 125% of the *greater of* the sales price or appraised value. For simplicity, let\u2019s assume each unit is valued identically at $100,000 so for every unit sold, the loan is paid down by at least $125,000 until the loan balance is zero.", "replies": [{"id": "f6v22ur", "text": "Thanks", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "f6rwz1j", "text": "If the perm loan is based on as-is LTV, is that based on the appraisal prior to construction or does there need to another appraisal near the completion of construction? In this case, I\u2019m talking about hotels. I\u2019ve seen banks that offer construction to permanent financing so I wanted to see if there was another appraisal event that could add risk of the values coming in under and creating a shortage.", "replies": [{"id": "f6rx130", "text": "Based on a new appraisal", "replies": [{"id": "f6rx3db", "text": "When is the new appraisal conducted?", "replies": [{"id": "f6rx5b7", "text": "After completion", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f6re53m", "text": "Are you solving for an IRR or a YOC?", "replies": [{"id": "f6t3tea", "text": "IRR - i know they are two different metrics for financial analysis, but why would what i am solving for be relevant in this scenario?", "replies": [{"id": "f6t6a0f", "text": "You ask in 2.1 if the cash flow is insufficient to cover the debt, if the project is a good deal or not. Any decent bank will never approve a loan that doesn\u2019t cover debt at a 1.25x, or better. But that measurement has nothing to do with wether or not you should pursue the project. It should first hit your IRR targets and also hot your YOC targets. Generally you want your unattended YOC to be a good gap between market cap rates for the project, otherwise your builder risk premium isn\u2019t worth it, and it would be best to go buy and existing asset. Generally you want that gap to be 120-150bps, maybe more as this is a smaller (relatively) project.\n\n\nHappy to discuss more offline.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f6t4og1", "text": "Anybody have any thoughts on the 1st scenario?", "replies": [{"id": "f6uuqq2", "text": "Quotes from a local general contractor is your best resource", "replies": [], "depth": 2}], "depth": 1}, {"id": "f6ycpmd", "text": "If you don\u2019t pay interest during the construction phase when the interest rate is higher than the perm loan, and the construction loan turns into a perm loan, when do you pay off the interest?", "replies": [{"id": "f70lue8", "text": "You would ideally pay the interest off at the end of the construction loan which would also ideally be the beginning of a perm loan or mezz loan", "replies": [{"id": "f70m8zy", "text": "So how does the construction loan turn into a perm loan? If you used 3m for construction, and it comes time to convert, how does that work?", "replies": [{"id": "f70tkax", "text": "My understanding from everyone's comments is that u use the lump sum from the perm loan to pay off the interest of the construction loan. But tbh I'm prob not even qualified to answer this. Someone please chime in lol", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}]