Securing the right construction loan is essential for the success of any property development project. Whether you’re developing a residential, commercial, or mixed-use property, understanding key financial terms like PRSV (Project Site Related Value) and soft equity can make a significant difference in your financing strategy. At Development Finance Partners (DFP), we specialise in helping developers structure the best financing solutions for their projects.
In this guide, we’ll explore how PRSV and soft equity can impact your construction loan, how different approaches to calculating Total Development Costs (TDC) affect your profit margins, and how a Loan-to-Development Cost Ratio (LTDCR) covenant can influence your financing.
What is a Construction Loan?
A construction loan is a short-term, high-interest loan used to cover the costs of building or renovating a property. Unlike traditional mortgages, construction loans are typically disbursed in stages (drawdowns) as the project progresses. The lender releases funds when key construction milestones are achieved, such as completing the foundation or framing.
Understanding PRSV and Soft Equity in a Construction Loan
One of the most critical concepts when structuring a construction loan is the Project Site Related Value (PRSV). The PRSV represents the adjusted value of the project site, calculated to achieve a target profit margin—typically 20%—on the Total Development Costs (TDC). This ensures that both the developer and the lender have a clear understanding of the project’s financial viability.
Why is PRSV Important for Construction Loans?
For a construction loan, the PRSV is vital because it helps determine the project’s overall profitability and can generate soft equity. Soft equity refers to the difference between the land's purchase price and its PRSV. This soft equity can reduce the developer’s cash contribution to the project, making it easier to secure favourable financing terms.
Example Scenario for a Construction Loan
1. Using PRSV with Soft Equity in Your Construction Loan
When applying PRSV in a construction loan, the Total Development Costs (TDC) are higher because the land value is adjusted upward to achieve the target profit margin of 20%. However, the soft equity generated by the PRSV reduces the developer's cash equity requirement.
Item | Amount ($) | Description |
|---|---|---|
Land Purchase Price | $1,500,000 | The actual price paid for the land. |
PRSV | $2,500,000 | The adjusted value of the land based on a 20% profit margin. |
Soft Equity | $1,000,000 | The difference between the land purchase price and the PRSV. |
TDC | $8,000,000 | Total project costs, including land costs based on PRSV. |
LTDCR (80% of TDC) | $6,400,000 | Loan amount based on 80% of the TDC. |
Developer's Equity Contribution | $1,600,000 | The developer’s equity contribution includes $1,000,000 in soft equity and $600,000 in cash. |
Profit | $2,000,000 | Profit based on a 20% margin of the TDC. |
Result: The developer’s cash equity requirement is reduced to $600,000 due to the $1,000,000 in soft equity. This makes the construction loan more favourable for the developer while maintaining a 20% profit margin.
2. Without PRSV: Using Land Purchase Price in the TDC for a Construction Loan
If the land purchase price is used directly in the TDC without applying PRSV, the Total Development Costs are lower, but the profit margin increases. This approach leads to a higher upfront cash equity requirement for the developer.
Item | Amount ($) | Description |
|---|---|---|
Land Purchase Price | $1,500,000 | The actual price paid for the land, included directly in the TDC. |
TDC | $7,000,000 | Total project costs based on the land purchase price. |
LTDCR (80% of TDC) | $5,600,000 | Loan amount based on 80% of the TDC. |
Developer's Equity Contribution | $1,400,000 | The developer must contribute the full equity amount in cash. |
Profit | $3,000,000 | Profit based on a 42.86% margin of the TDC. |
Result: The developer needs to contribute $1,400,000 in cash equity but enjoys a significantly higher profit margin (42.86%) due to the lower TDC. However, there is no soft equity to reduce the upfront contribution.
Comparison: PRSV with Soft Equity vs. Without PRSV in a Construction Loan
Aspect | With PRSV & Soft Equity | Without PRSV (Land Price in TDC) |
|---|---|---|
Land Purchase Price | $1,500,000 | $1,500,000 |
PRSV | $2,500,000 | Not applicable |
Soft Equity | $1,000,000 | Not applicable |
TDC | $8,000,000 | $7,000,000 |
LTDCR (80% of TDC) | $6,400,000 | $1,400,000 |
Developer's Cash Equity | $600,000 | The developer must contribute the full equity amount in cash. |
Total Developer Equity | $1,600,000 (including soft equity) | $1,400,000 |
Profit | $2,000,000 | $3,000,000 |
Profit Margin | 20% | 42.86% |
Key Insights for Developers Seeking Construction Loans
- Using PRSV with Soft Equity:
- The TDC is higher due to the PRSV adjustment, but the soft equity reduces the developer’s cash equity requirement.
- This approach is beneficial for developers who want to reduce their upfront cash contribution while still achieving the target 20% profit margin required by lenders.
- Without PRSV (Using Land Purchase Price in TDC):
- The TDC is lower, which leads to a higher profit margin. However, the developer must contribute more cash equity since no soft equity is generated.
- This approach may be more suitable for developers who have access to more cash and want to maximise profit margins.
- LTDCR (80%): In both scenarios, the lender finances 80% of the TDC, but the loan amount is larger when PRSV is used. This provides more flexibility in project funding and reduces the developer’s cash burden.
Conclusion: Construction Loan Strategies with PRSV and Soft Equity
The use of PRSV and soft equity in a construction loan provides developers with a flexible way to manage their financing and equity requirements. While using the land purchase price in the TDC can lead to higher profit margins, leveraging PRSV allows developers to reduce their cash equity contribution, making it an attractive option for many.
At Development Finance Partners, we specialise in structuring financing solutions tailored to your development needs. Whether you’re looking to leverage PRSV or optimise your cash equity contributions, we can help you secure the right construction loan for your project. Contact us today to learn more about how we can assist you in structuring the best financing package.
