What Is a Draw in Real Estate & How Does It Work?

Understanding a Real Estate Draw

A real estate draw represents a partial release of funds from a larger loan, most commonly a construction or development loan. Unlike a traditional mortgage where the entire loan amount is disbursed at closing, a draw system ensures that funds are released incrementally. This controlled disbursement aligns with project progress, preventing the entire loan from being distributed before it is needed.

The core concept behind a draw is that money is provided as specific project milestones are met or as verified expenses are incurred. Lenders favor this approach as it significantly mitigates their risk, ensuring that loan funds are utilized strictly for their intended purposes, such as purchasing materials or paying contractors. This method also allows lenders to monitor project progress and financial health throughout the construction phase.

From the borrower’s perspective, draws offer benefits by managing cash flow effectively. Borrowers only pay interest on the portion of the loan that has actually been disbursed, rather than on the full committed loan amount. This approach can lead to substantial interest savings over the life of a construction project, as interest accrues only on the funds actively in use. Incremental funding is designed for projects where collateral value increases as work progresses.

The Draw Process

The process of obtaining a real estate draw begins with the initial loan agreement, which typically includes a detailed budget breakdown and a schedule of values for the project. This documentation outlines the planned expenditures and the various stages at which funds will be needed.

Once a defined phase of work is completed on the project, such as the foundation pouring or framing completion, the borrower can initiate a draw request. Before funds are released, a lender’s representative, often an independent inspector or appraiser, will visit the site to verify the completed work. This verification ensures that the work aligns with the approved plans and that its value corresponds to the requested funds.

Following successful verification, the borrower submits a formal draw request package to the lender. This package typically includes detailed invoices for work performed and materials purchased, along with lien waivers from contractors and suppliers. Lien waivers are legal documents that relinquish their right to place a lien on the property, protecting the owner and lender from future claims.

The lender then conducts a thorough review of the submitted request against the initial budget, the inspection report, and the terms of the loan agreement. This review process ensures compliance and accuracy before any money changes hands. Upon approval, funds are disbursed, often within a few business days, either directly to the borrower or, in some cases, directly to the contractors and suppliers involved in the project.

It is common for lenders to retain a certain percentage of each draw, known as a holdback or retainage, typically ranging from 5% to 10% of the disbursed amount. This held-back amount is usually released at the very end of the project, after final inspections and the receipt of all necessary certificates of occupancy, serving as an additional layer of financial protection for the lender.

Typical Scenarios for Real Estate Draws

Real estate draws are fundamental to financing new construction projects, whether residential homes, large-scale commercial buildings, or industrial facilities. In these scenarios, funds are incrementally released as different construction phases are completed, such as site preparation, foundation work, framing, roofing, and interior finishes. This ensures money is available precisely when specific work is ready to be paid for.

Renovation and rehabilitation loans also heavily utilize the draw system for significant property improvements. For projects involving extensive remodeling or structural changes, funds are disbursed as various stages of the renovation are completed and verified. This methodical approach helps manage the financial aspects of complex rehabilitation efforts, aligning expenditures with physical progress.

Land development loans frequently incorporate draws to fund the installation of necessary infrastructure on raw land. This includes expenses for creating roads, installing utility lines for water, sewer, and electricity, and preparing the land for future construction. Each phase of infrastructure development triggers a subsequent draw, ensuring that capital is deployed efficiently for these preparatory stages.