The in-balance test worked at one draw: the revised cost to complete, the retained contingency, the shortfall the sponsor must fund, and why loan-to-cost barely moves.
Before every draw, the lender checks that the undrawn loan plus any equity still to come covers the full cost to complete, including interest and a retained contingency. If it does not, the loan is out of balance and the sponsor must fund the gap before another euro is advanced. On an illustrative 60,000,000 scheme, a 25 per cent overrun on the remaining build cost leaves 17,125,000 to complete against 15,000,000 undrawn: a 2,125,000 shortfall, only 3.5 per cent of the budget, and the loan stops until it is paid in.
Worked in full in The Real Estate Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The cost-to-complete test, also called the in-balance or balancing test, is the lender's main protection in a development loan. It does not ask whether the project is still profitable; it asks whether the money available is enough to finish the building, which is the only state in which the collateral is worth what the credit paper assumed.
| Budget line | Budget | Spent at draw | Remaining |
|---|---|---|---|
| Land | 12,000,000 | 12,000,000 | 0 |
| Hard costs | 36,000,000 | 26,000,000 | 10,000,000 |
| Contingency | 2,000,000 | 0 | 2,000,000 |
| Soft costs | 6,000,000 | 4,500,000 | 1,500,000 |
| Interest reserve | 4,000,000 | 2,500,000 | 1,500,000 |
| Total | 60,000,000 | 45,000,000 | 15,000,000 |
Funding: 18,000,000 of equity (30 per cent), spent first, and a 42,000,000 loan (70 per cent loan-to-cost). At this draw, 75.0 per cent of the budget has been spent, the loan has advanced 27,000,000 and 15,000,000 is undrawn. On the original budget the loan is exactly in balance.
Step 1: the revised cost to complete. The monitoring surveyor certifies that the remaining hard costs are 12,500,000, not 10,000,000: an overrun of 2,500,000, or 25.0 per cent of what was left to build. Three months' delay adds 200,000 of soft costs and 800,000 of interest.
Step 2: the contingency. The 2,000,000 budget contingency is used against the overrun, but the facility requires 5 per cent of the remaining hard cost to stay unspent as contingency until completion.
Cost to complete = hard 12,500,000 + soft 1,700,000 + interest 2,300,000 + retained contingency 625,000
= 17,125,000
Step 3: the sources still available. With equity spent first, the only source left is the undrawn loan.
Sources = undrawn loan + equity not yet contributed = 15,000,000 + 0 = 15,000,000
Shortfall = 17,125,000 − 15,000,000 = 2,125,000
Excel: =MAX(0, SUM(cost_to_complete) - (loan - drawn) - equity_remaining)
Step 4: rebalance. The facility agreement requires the sponsor to deposit 2,125,000 into a controlled account, or spend it on the project, before the next draw. Total cost rises to 62,125,000, and if the sponsor pays, the loan-to-cost falls to 67.6 per cent: the lender's position improves. If the lender funds the gap instead, its loan becomes 44,125,000 and its loan-to-cost 71.0 per cent, above the 70 per cent the credit committee approved.
| Overrun | Overrun amount | Cost to complete | Shortfall | LTC if lender funds |
|---|---|---|---|---|
| 10% | 1,000,000 | 15,550,000 | 550,000 | 70.3% |
| 20% | 2,000,000 | 16,600,000 | 1,600,000 | 70.8% |
| 25% | 2,500,000 | 17,125,000 | 2,125,000 | 71.0% |
| 30% | 3,000,000 | 17,650,000 | 2,650,000 | 71.3% |
| 40% | 4,000,000 | 18,700,000 | 3,700,000 | 71.7% |
| 50% | 5,000,000 | 19,750,000 | 4,750,000 | 72.2% |
The loan-to-cost barely moves, which is exactly why it is the wrong number to watch. A 50 per cent overrun on the remaining work lifts LTC from 70.0 to only 72.2 per cent if the lender funds it, but the shortfall it creates, 4,750,000, is more than a quarter of the equity the sponsor put in. The test measures money, not ratios, because a building three quarters complete is worth far less than three quarters of a finished one.
Even a 10 per cent overrun, smaller than the budget contingency, fails the test here. The contingency covers the overrun, but the soft cost and interest from the delay, plus the contingency the lender insists on keeping, do not fit inside the 15,000,000 undrawn.
Testing against the original budget instead of the certified cost to complete. A loan that is in balance on paper, 15,000,000 remaining against 15,000,000 undrawn, can be 2,125,000 short in reality, and the gap only appears if the surveyor's revised figures and the interest on the delay are put into the test. The second error is to let the contingency run to zero. Without the retained 625,000, the shortfall would be 1,500,000 and the lender would be funding the last months of construction with no buffer left for the next surprise.
The funding order matters for who carries the risk, not for the size of the gap. If equity were drawn pro rata instead of first, 4,500,000 of it would still be due and the shortfall would be the same 2,125,000, but the lender would also be exposed to a sponsor who cannot meet the remaining calls. The trade-off is set out in equity first vs pro rata development funding.
The book's development chapter sets out the drawdown test and the cases it is meant to catch; the free workbook and case files include a scheme where the test fails by the whole overrun because the equity went in first. Interest on the drawn balance is worked month by month in how to calculate interest on a development loan.
The lender stops funding draws until the sponsor deposits the shortfall or spends it on the project. In the example the cost to complete is 17,125,000 against 15,000,000 undrawn, so the sponsor must put in 2,125,000. If it does not, the failure is usually an event of default, though most lenders negotiate before enforcing.
Unspent contingency can absorb an overrun, but many facilities require part of it to stay unspent until completion. With 5 per cent of the remaining 12,500,000 of hard cost retained, 625,000 is added to the cost to complete, raising the shortfall from 1,500,000 to 2,125,000.
Because the overrun is small against the whole budget. A 50 per cent overrun on the remaining hard cost raises LTC from 70.0 to 72.2 per cent if the lender funds it, yet creates a 4,750,000 shortfall, more than a quarter of the sponsor's equity. The test is about cash to finish, not the ratio.
This article is one calculation from The Real Estate Debt Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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