Operating Deficit Account – Construction lending

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Operating Deficit
Posted by: Ron May 25 2004, 06:04 PM
I was directed to your website in search of a good definition of Operating Deficit, but the article didn’t go into any detail about the operating deficit.

I’d like to get a good definition of “Operating Deficit”. What is the transaction that triggers the entry as an operating deficit?
Posted by: loanuniverse May 26 2004, 09:15 AM
Operating Deficit?

For a second there I was a little confused at your question. Frankly, I don’t remember talking about operating deficit, but I guess you arrived at the website because one of my articles on construction loans talked about the “operating deficit account”. I am going to try to give you as good of a definition of “operating deficit account” as it pertains to construction lending, but not sure if that is exactly what you are looking for.

The operating deficit account is used in construction lending as a safeguard to assure that there will be enough money for interest to be repaid during the period between the end of construction and the time that either the units that were constructed are sold or they are leased. A construction loan usually provides funding for two types of development costs. Hard Costs { pretty much the actual construction } and Soft Costs {architect fees, zoning changes, marketing, interest reserve, operating deficit, etc.}

Taking into consideration that the construction lender is going to get taken out by either the sales of the units or permanent financing once the units are leased, the construction lender will want to make sure that there is enough money to make interest payments during the construction and marketing/lease up period. I think this would work better with an example. Therefore lets assume that you have a project to build 10 townhouses to be sold for $200,000 with each townhouse to cost $100,000 resulting in a $1,000,000 construction loan. The construction phase of the project will take 24 months and there will be a 3-month period after construction during which the closings will occur.

In the example cited, an interest reserve would be set up for the 24-month construction period and this will usually be funded on a monthly basis adding to the amount outstanding. However, once construction is finished the interest payments will be coming from the operating deficit account.

You also have to take into consideration that these funds that were approved as part of the construction loan might have a certain level of flexibility attached to them. For example, the developer might need to pay the people in charge of the leasing office and the marketing budgeted might be short. In a case like that, the developer could appeal to the lender to let him have some of the operating deficit account money.

The whole thing of course can be very much more complicated than what this example shows.

If this is not what you were looking for, it would help if you give me more information regarding the contextual use of “operating deficit”.
Author: Commercial Loan Underwriter