Sources & Uses: Following the Real Estate Money Trail

Use of Funds

The Uses of Funds detail is a project-level accounting of all project costs across all categories.  The Uses of Funds section is derived before the Sources of Funds and dictates how much funding is needed.  The sponsor will typically break project costs into price per square foot or per unit, depending upon the property class.  The sponsor may also show items as a percentage of overall costs.  Although there are myriad ways to group project costs, the most common is to start with three basic categories: purchase price, hard costs, and soft costs. These categories may be broken into line item sub-costs or rolled up in order to simplify the table.

Purchase Price

The purchase price is fairly self-explanatory; it is the price that the operator pays to acquire the land and any improvements, such as buildings and infrastructure.  If the land is not being purchased outright as part of the transaction, then it is the price of the lease-hold interest on the building being acquired.  Showing the price per square foot here can be useful to show how the cost of acquisition compares to other recent transactions for similarly situated assets.

Hard Costs

Hard costs are items that directly improve the property such as construction labor and materials.  Sometimes a sponsor will include a hard cost contingency in case of overruns.  Again, it can be useful to break these costs into a price-per-square-foot view to get a sense of how competitive the pricing is to the market.

The amount and type of hard costs can provide some insight into the business plan.  For example, suppose an investor is comparing two offerings that both carry a total value of $30 million. In the first deal, a sponsor allocates $1 million in hard costs, while in the second the sponsor allocates $12 million to hard costs.  The first deal probably is core-plus, with perhaps some deferred maintenance work or pre-funded speculative tenant improvements.  The second deal clearly is more of a value-add project with significant property renovation planned.

If the sponsors further break down these costs, the business plan becomes clearer. Suppose the second table is further itemized in two different ways:

Notice that the first table shows improvements to mechanical systems, roof repairs, seismic improvements and parking garage repairs.  This suggests that property has substantial deferred maintenance that the sponsor needs to address in order to catch the property back up to current market standards and retain tenants.  Alternatively, the second table allocates significant funding to speculative improvements to interior common areas and landscaping and then allocates funds towards funding future tenant improvements.  The second table of uses is likely intended to entice new tenants to lease space at the property at the best prevailing market rates..

Soft Costs

Soft costs are costs associated with the project but that do not provide tangible improvement value.  This category is the most varied and include but is not limited to:

• Purchase closing costs

• Leasing commissions

• Legal fees

• Organizational fees

• Loan acquisition costs

• Capital broker commissions

• Interest reserves

• Equity reserves

It is less useful to show soft costs on a square footage basis, but showing the proportion of soft costs to total project costs can help give a sense of the efficiency with which a sponsor is executing a business plan. In addition, the number of reserves (both interest and equity) can provide insight into the amount of uncertainty in the execution of the business plan. In general, the more uncertainty the higher the reserves.

Sources of Funds

The Sources of Funds section of the table will very nearly match the capital stack, but it will have a few key differences.  First, while the capital stack will show the capital providers for a project and their relative order of repayment priority, the Sources of Funds section takes a deeper dive to show all of the sources of funds in a deal in addition to capital providers.  One item that may be listed as a source of funds is operational cash flow.  Ground-up development and capital improvement programs can take a long time to complete.  Often, the operator can rent a portion of a property while making improvements to another.  So, while a portion of the improvements may be funded by investor dollars, a portion may be funded by rents in order to reduce up-front capital needs.  However, the Uses of Funds must match the Sources of Funds, so the sponsor will need to include these cash flows in the table.

Another detail that the Sources of Funds section adds is the fund timing.  Some funds go to work at closing, while others may be held in escrow to pay taxes or insurance. Cash flow, for example, is one source that is usually put to work on future expenses rather than immediately at closing.  Additionally, a sponsor may break down the debt into the initial funding and future funding to be drawn as needed.  The capital stack, however, would simply show the total debt irrespective of timing. This can provide a particularly helpful distinction because, oftentimes, the future funding of debt is contingent upon certain events that are anticipated but not necessarily known to occur. Therefore, in this situation, the actual amount of debt may end up settling at an amount that is different than what is depicted in the capital stack. Understanding the debt sources will give you a sense of both the initial and future funding, which will translate into the final amount of debt.

As the Sources of Funds section becomes more complex, it becomes more likely that the project itself will be complex and will require an experienced sponsor to successfully carry it out.

What’s the takeaway for investors?

The Sources & Uses table is not intended to provide forensic accounting. Instead, it helps to provide a funding road map for how the funds will be raised and how they will then be spent on a project.  It is perhaps the single best tool for a quick understanding of a project’s particular business model and the expertise it will require to carry out. For these reasons, CrowdStreet will always display a Sources & Uses table on the detail page of its Marketplace offerings.