SIGNAL OR NOISE · THE ECONOMY · COLLATERAL MARKETS
A loan is secured on a shopping centre valued 14 months ago. Since then comparable centres have sold at yields a full point higher, and the anchor tenant has given notice.
// WORKED EXAMPLEHOW THE DRAWDOWN WORKS
Equity First: The Drawdown Order on a Development Loan
The developer's money goes in first, so it is the first money lost.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
Picture a development that stops four months in. If the loan was drawn equity first, the bank has lent little, because the developer's money was to be spent before any of its own; if the two were drawn side by side, the bank has already paid its share of every invoice. That difference in the bank's position during the riskiest months is what the term buys. It is written as a condition of the first drawdown, evidenced by the lender's surveyor against invoices and the land settlement, and tested again whenever the developer's contribution turns out to include something other than cash.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// MAKE THE CALL
Issue 08 — Basalt Ridge Developments. A new-to-bank developer, a claimed 28% ROE and two other banks circling. Your bank has a growth target. Your call first, then the senior banker's.
// 01 — WHY THE ORDER MATTERS TO A LENDER
The early months of a development carry risks the later ones do not: ground conditions, demolition, consents that turn out narrower than hoped, a builder finding its feet. If the project fails then, the site is worth little more than the land, and every dollar already spent on it is largely lost. Whoever has funded those months takes that loss.
Spending the developer's money first puts that loss on the developer. It also keeps the developer's attention on finishing, because its money is already in the ground and the only way to recover it is to complete and sell. By the time the bank's money starts going in, the site has been bought, the early works are done, and the riskiest stretch is behind the project.
// 02 — HOW IT IS WRITTEN AND EVIDENCED
The usual form is a condition precedent to the first advance: evidence that the equity has been contributed and applied to project costs. The evidence is the land settlement statement, paid invoices for fees and early works, and the lender's quantity surveyor reconciling what has been spent against the budget. Any equity not yet spent commonly sits in an account the lender controls. Money the owners put in as shareholder loans is commonly required to be subordinated, so that it cannot be repaid ahead of the bank.
Two alternatives exist. Pro rata drawing splits every invoice between the developer and the bank in the agreed shares from the start. Back-ended equity lets the loan go first while the developer's share is committed and secured, by cash held aside or a letter of credit from a strong backer; it is more often seen in project finance than in mid-market property. Whichever applies, the cost to complete test runs at every drawdown afterwards.
// 03 — THE EXAMPLE
A developer of light-industrial units, constructed for this page like every figure in it, has a US$16.0m budget: land US$3.2m, construction US$10.4m, contingency US$0.5m, fees US$0.9m and finance US$1.0m. The bank lends US$11.2m, 70% of cost, a level that belongs to the example; the developer contributes US$4.8m. At month four, with US$6.0m spent on the land, fees and foundations, the developer's main tenant prospect withdraws and the project stops. The stalled site would fetch US$3.5m in a forced sale.
Equity first Pro rata (30 : 70)
Spent to month four 6.0 6.0
Paid by the developer 4.8 1.8
Lent by the bank 1.2 4.2
Forced-sale value 3.5 3.5
Bank's position covered 0.7 short, before costs
Both loans are at 70% of cost on paper. Only the drawdown order differs, and it decides whether the bank loses money on a project that stopped early. Now look at what made up the US$4.8m. Suppose the land went in at a valuation of US$3.2m, though the developer bought it years ago for US$2.0m, and US$0.6m of the equity is a development fee the developer has charged the project and deferred:
Equity as presented 4.8
land at valuation (bought for 2.0) 3.2
development fee, deferred, not paid 0.6
cash 1.0
Developer's money actually at risk 2.0 + 1.0 = 3.0
Loan against cash cost 11.2 ÷ (16.0 − 1.2 − 0.6) = 11.2 ÷ 14.2 = 79%
On paper the bank funds 70%; in cash it funds 79%, and its first advance comes after only US$1.0m of new money. A mezzanine loan described as the developer's own funds does the same thing differently: the money is real, but it belongs to a lender that will want repaying.
// 04 — THE TESTS A LENDER READS BESIDE IT
Loan to cost fixes the size of the developer's share, and the cost to complete test keeps the project in balance after the equity is spent. Equity first adds the third dimension, the bank's exposure along the way, which the example shows neither of the others measures. The three are read together because each can be met while another fails.
The capital rules that test development equity look at its amount rather than its order. The Basel Committee's standardised approach lets residential development lending carry a lower risk weight where the underwriting meets its real estate standard and either pre-sales or pre-leases are significant or the borrower has substantial equity at risk against the as-completed value, and leaves the levels to national supervisors. Australia's APS 112, for banks on the standardised approach, tests total debt against qualifying development costs for residential development lending. Neither says when the equity must be spent.
DEFINED IN ONE PARAGRAPH → · DRAWING A DEVELOPMENT LOAN → · LOAN TO COST, DEFINED →
// 05 — WHERE IT DECIDES A FILE
The term sheet is where it is argued. A developer with several projects wants its cash to work across all of them and asks for pro rata drawing or back-ended equity; the lender asks what security stands behind the promise to pay later. Lenders differ on land: some count it at cost, some at an independent residual land value or other valuation, some at the lower of the two. Deferred fees and related-party costs are often excluded or counted only once paid.
The moment it bites is the first drawdown request. The lender's surveyor confirms the equity has been spent on the project, not merely deposited, and the bank funds only then. A developer that arrives with part of its contribution still to come has, in practice, asked for a different loan, and the credit paper should say so.
PROPERTY DEVELOPMENT FINANCE → · MEZZANINE FINANCE → · ISSUE 08 · EQUITY IN FIRST →
// SOURCES
The documents the statements on this page rest on. Each was opened and checked when cited.
- Basel Committee on Banking Supervision, Basel Framework, CRE20 Standardised approach: individual exposures — paragraphs CRE20.90 and CRE20.91 and footnote 42 — Sets a 150% risk weight for land acquisition, development and construction exposures and allows 100% for residential ones that meet the underwriting requirements and have significant pre-sales or pre-leases or substantial borrower-contributed equity at risk against the as-completed value, with levels left to national supervisors — section 04.
- Australian Prudential Regulation Authority, Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (2025) — Attachment A, paragraphs 27 to 30 — Defines land acquisition, development and construction exposures and allows a 100% risk weight for residential ones only where, among other conditions, total debt is below 75% of qualifying development costs — section 04.
// QUESTIONS PEOPLE ASK
- Does the developer's equity have to go in before the bank lends?
- On many development loans, yes: the facility agreement makes evidence that the equity has been spent a condition of the first advance. It is a negotiated term, not a law. Some lenders accept equity drawn alongside the loan, and some, mainly in larger or project-finance deals, accept equity paid in last if it is committed and secured by cash or a letter of credit. The order a loan uses is set out in its conditions precedent and drawdown clauses.
- Can land count as equity in a development loan?
- Usually, if the developer owns the site and it is part of the project. The question is the figure. Land counted at its purchase price is money the developer actually spent. Land counted at a higher current valuation includes a gain that exists only if the scheme's prices and costs hold. Lenders take different views, and many read the cash a developer has put in separately from the uplift.
- What is pro rata funding on a development loan?
- Pro rata funding splits each payment between the developer's equity and the bank's loan in fixed shares from the first invoice. On a project funded 30% by equity and 70% by debt, every US$1m of cost is met with US$300,000 of equity and US$700,000 of loan. It keeps the developer's cash free for longer, and leaves the bank with a larger exposure early in the build than equity-first drawing would.
- What happens to the developer's equity if the project fails?
- It takes the loss first. The bank's loan is secured over the site, so on a sale the proceeds go to the bank, after enforcement costs and any creditors ranking ahead, before anything returns to the developer. If the project stops early under equity-first drawing, the developer may lose most of its contribution while the bank recovers its smaller advance in full. Shareholder loans the developer made to the project rank behind the bank under their subordination terms.
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