Hard Costs vs Soft Costs

The longer version

Hard costs pay for what gets built. They include site work, foundations, structure, the building envelope, mechanical, electrical and plumbing systems, finishes, the general contractor's general conditions and fee, and usually a hard cost contingency. They are billed through the contractor's schedule of values and verified on site.

Soft costs pay for what makes building possible. Typical lines are architecture and engineering, permits and impact fees, legal and accounting, insurance including builder's risk, property taxes during construction, appraisal and third-party reports, loan fees, interest during construction, leasing and marketing, developer fee and a soft cost contingency. Land is normally a separate line from both.

Construction lenders care about the split for three reasons. First, loan to cost is measured against the total of land, hard and soft costs, so every line in the budget is underwritten. Second, the two are funded differently: hard costs are drawn against inspected progress, while soft costs are drawn against invoices, and interest during construction is often funded from an interest reserve inside the soft cost budget. Third, overruns behave differently: hard cost overruns come from the work, soft cost overruns mostly come from time, because delay keeps interest, taxes and insurance running.

The budget a lender closes on shows hard costs, soft costs, land and contingencies as separate categories, and the loan agreement usually limits moving money between them without consent. Reallocations, especially of contingency, are one of the most common draw-time requests.