Posted by Sarah Ahnen and Gerard Sablich
In the real estate development industry, a construction draw is a formal request for funds from capital partners or lenders in accordance with an approved construction budget. Often, these draws are inaccurately treated as administrative tasks. In reality, they are one of the highest risk financial control points in the entire life cycle of a project. Every month, millions of dollars can move based on a draw package. If that package is weak, incomplete or poorly reconciled, developers expose themselves to overbilling, lien risk, strained capital partner and lender relationships, and hidden budget overruns.
The draw process isn’t paperwork. It’s capital protection. Below illustrates what your financial team can do to turn this monthly task into a strategic financial control point to benefit your real estate development projects.
What is the Purpose of Construction Draws?
A construction draw functions as a compiled submission of project costs, primarily contractor pay applications and vendor invoices, that have been incurred during a given period (usually monthly). The draw allows lenders or capital partners to review these costs within the construction budget, often alongside a progress inspection, and then fund from available debt and/or equity.
Lenders rely on construction draws to:
- Mitigate risk by only releasing funds for work that is an approved construction cost and has been verified to be complete by a third-party inspector;
- Monitor budget variances and contingency usage throughout the project life cycle; and
- Realize increased property value as each installment of the loan money is released, further protecting their investment.
Developers, on the other hand, rely on construction draws to:
- Gain access to capital crucial to paying their vendors on time;
- Track costs spent to date and future commitments; and
- Ensure the project is within the planned budget.
Five Components of a Good Construction Draw Package
- Sources & Uses: This part of a construction draw package tracks budget and cost activity for each individual line item, as well as the sources of funding for each draw. Draws are commonly funded first by owner equity and then shift to loan advances once the required equity contribution has been satisfied. Some construction loans may be structured as Pari Passu, where each draw is funded by a specified percentage of equity and loan.
- Sworn Owner’s Statement: This is a common lender requirement that includes a list of commitments the owner has with each vendor on the project, where the owner is swearing the information provided on the statement is true and accurate.
- Disbursement Listing: This provides each vendor’s name and address as well as the total due to vendors requesting payment in the current month’s draw. This listing is a helpful tool for title companies or accounts payable to help ensure all payments issued tie to the draw.
- Invoice Listing: An invoice listing provides details for each entry in the draw, arranged by budget category, and often includes the vendor name, invoice number, invoice date, description of work, invoice amount and, of course, budget category.
- Invoice Backup: The invoice backup provides support for each line item on the invoice listing. Construction draws should include actual invoices and check copies (for reimbursements) arranged in the same order as the invoice listing. This allows lenders to review all items within each budget category and ensure they represent legitimate construction-related work, are applicable to the assigned budget and have not been reimbursed in a prior draw.
Common Construction Draw Pitfalls: Pace of Payments, Budget Blind Spots and Financial Leakage
Construction requires constant pivoting to stay on budget and on schedule. Many developers spend most of their time on the job site, which can create a challenge when it comes to processing invoices on time. Below are three pitfalls to avoid:
- Falling Behind on Vendor Payments. When draw funding is delayed or stopped entirely the impact can have spiraling effects. Vendors may file liens against the property, causing a halt to draw funding until the lien is resolved. Insufficient funds for permits can delay progress and increase costs. Company overhead shortages can occur if construction management and development fees aren’t paid regularly. Unpaid insurance premiums can lead to cancellation of coverage and further delays in lender funding.
- Budget Blind Spots. Incomplete or delayed draws can limit a developer’s ability to make strategic budgeting decisions. If a draw captures costs from two to three months prior, the developer is operating without full visibility. More recent costs may be missing that could significantly impact the budget.
- Financial Leakage. When it comes to construction draws, financial leakage refers to money that is paid out but does not go toward the intended construction work or approved budget. Think of a construction draw as tightly controlled funding — each dollar is expected to match verified progress. Leakage occurs when some of that money “escapes” the system.
Common ways financial leakage occurs:
- Overbilling: A contractor invoices for more work than actually completed.
- Duplicate payments: The same invoice or cost is paid twice.
- Late fees
- Missing costs: Failing to reimburse items paid outside the draw.
- Unapproved change orders: Funds are used for work not formally approved.
- Misallocation of funds: Money intended for one part of the project is used elsewhere.
- Poor documentation: Weak controls allow errors or inflated costs to go unnoticed.
In short, financial leakage in construction draws is any gap between money disbursed and real, verified progress or approved costs. Controlling that leakage is a critical part of construction lending and project management.
Five Benefits of a Solid Draw Package
In addition to paying construction invoices on time, as a developer, you also must constantly predict and react quickly to potential problems and budget overruns. But how can you do this if you’re looking backwards at costs from months ago? You could be experiencing a major budget overrun before you even know there’s a problem. A streamlined draw process can help you get ahead of the chaos:
- Consistently process and pay vendor invoices within a 30-day window. This greatly minimizes the risk of liens, which can delay construction and skyrocket costs.
- Ensure you have access to reports showing current costs spent per date, allowing for real time, strategic decisions when approving invoices, change orders and monitoring the timeline of the project.
- A comprehensive sworn owner’s statement can track multiple contracts within a budget line so developers can see all committed costs within that budget. It’s essential to update the statement any time contracts increase or decrease, so both project managers and lenders can see an accurate picture of past and future costs.
- Since a construction draw package tracks your total costs spent to date by budget category, it’s an excellent tool to use for forecasting job costs for future projects. Developers can analyze costs by category, vendor, month, etc. and use that information to increase profitability in the future.
- Strengthen relationships with vendors and lenders. Being the preferred choice for vendors to work with ultimately lowers costs. A dependable draw process allows for consistent cash flow and on-time payments to vendors, and often quicker turnaround on lender funding.
Don’t Fear the Lender
It’s easy to look at the construction draw process and see the lender as the obstacle that’s preventing progress. That doesn’t need to be the case. Lenders ultimately have the same goal as developers, to build on time and on budget. So how can this relationship be treated as a partnership instead of an obstacle?
Make their job easy. If it’s 4:45 p.m. on a Friday and a lender has time to review one more project, they’re probably going to choose the draw they know won’t be a hassle. Consistently providing lenders with complete and accurate draw packages builds trust, which can strengthen the relationship and allow for more business opportunities down the road. Lenders are typically looking for:
- Transparency. Costs in the draw are supported with invoice backup that clearly describes the work included. Budget changes are easy to follow and communicated in advance when required by the loan documents. Committed contract costs are included in the sworn owner’s statement.
- Consistency. Draws are submitted on a regular basis using a consistent format.
- Accuracy. Costs flow from one draw request to another without any gaps. Invoices are recorded correctly, and the draw is reconciled with the project financials.
- Adherence to Loan Documents. Budget and draw submission guidelines are followed as outlined in the loan documents.
Real estate development requires constant monitoring and flexibility to stay on time and on budget. By treating construction draw production as a strategic process, developers can make informed budgeting decisions, avoid delays, strengthen vendor and lender relationships, and improve forecasting and profitability.
If your team doesn’t have the capacity or expertise to handle construction draws, accounts payable or project accounting, consider outsourcing as a viable option. Many developers choose to outsource these functions, bringing national best practices, capacity and specialized expertise to the table, so they can stay focused on construction and project execution.
Contact Sarah Ahnen, Gerard Sablich or a member of your service team to discuss this topic further.
In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.