As part of any construction project and risk mitigation practices it is critical that you evaluate the project early and with a critical eye.
A simple way is to perform a project feasibility prior to your loan commitment or funding of any project. Project Feasibility reports differ greatly based on the size and scope of the project. It is a generic term used to review the contractor, bid, scope of work, plans, specs, permits and contracts of a specific project. This step is probably the most critical step in the origination process because if you skip it, and fund a back project you can’t get out of it and you may end up with an under-funded, half built piece of real estate and if you have an REO in this phase you will, as my friend Paul Sievers of Geraci Law Firm would say, “you will get a spin on the wheel of pain”.
When reviewing a project, you need to make sure that the contractor who bid it has the experience to complete the project. Its sounds easy but most skip this step and only find out later the person was a friend of a friend and unlicensed and uninsured. Is the scope of work specific, accurate, and properly bid to complete the project? What does Kitchen - $25,000 mean to you? How do you inspect it and how do you value that line item? New Cabinets, Home Depot SKU# 364756 – 100 LF $10,000. This type of detail allows proper costing analysis, better valuation, clear expectations of the contractor and ability to actively manage the fund control process. Does your project require permits? Does your contractor say it doesn’t? Do you (or your borrower) want a “Stop Work” order placed on the project, delaying or derailing the project and send it into cost over runs? Is there a contract with the contractor for a fixed price or just a bid? If the contractor under bid the project in hopes of getting change orders approved, who pays for it? Is your borrower able to kick in the required cash? If the original contractor walks off the job is there sufficient funds available for the lender/borrower to hire another contractor to finish the project to your approved scope? By not opening the can of worms in the beginning of the process and having the ability to pass on a project you may end up with a busted construction project.
A few things you should always do:
Validate the Contractor; background, license, insurance, references, size/scopes of past jobs
Perform a costing analysis on a detailed bid and review contracts
About the Author, and CFSI
Brian Mingham is the founder and CEO of CFSI Loan Management, a Los Angeles based company that works with lenders to mitigate the risks associated with construction loans. CFSI oversees the entire process, from contractor review, to project feasibility reviews, fund control, and draw inspections. Through this process, CSFI helps ensure that a construction project is completed on time, on budget, free of mechanic’s liens, and ready for permanent financing.
Lending on construction projects include inherit risk. CFSI Loan Management provides lenders with a resource to reduce this risk, without the expense of creating an internal construction operation.