Righting the Ship on Distressed Construction Loans

With challenges plaguing the construction industry over the last few years—material shortages, supply chain disruptions, shortage of qualified labor—it’s hardly surprising that so many construction projects have gotten off track. If you are the lender on a distressed construction project, you may be faced with the dilemma of taking over the project or adding more capital to “right the ship.” This decision requires a thorough understanding of current project status and what is required to bring the project to successful completion. Below are some key considerations for lenders in this scenario.

Understanding the Current Project Status

Assessing the status of a construction project goes well beyond visual inspection. In addition to determining how much of the project plan has been executed, it is critically important to dig into project documents and interview relevant parties to determine the following:

• Quality: Has the work completed to date been executed according to plan, and is the quality of execution satisfactory/?
• Compliance: Have all required permits been procured, and all required inspections passed? Does the project comply with all applicable laws, such as zoning and accessibility?
• Financial: Are all contractors and suppliers paid current? Have any liens been filed?
• Immediate Risk: If the project is stalled, is the site vulnerable to theft, vandalism, or exposure to the elements?

If a lender lacks sufficient internal resources to thoroughly investigate these concerns, a qualified construction consultant can provide a Construction Status Review.

Understanding Completion Requirements

With a complete and realistic picture of project status, the lender must next evaluate factors that support project completion and determine whether the project will have sufficient value at completion to cover the outstanding balance of the loan. Consider:

• Budget: Are remaining funds adequate to cover the remaining scope/? Construction consultants may provide a Cost-to-Complete Study to address this question.
• Schedule: Is the existing project schedule realistic? If project delivery is delayed, how will that impact project value?
• Contractor: Does the contractor have adequate skill and resources to complete the contract? A Contractor Evaluation can help determine whether a general contractor is qualified to complete the project.
• Borrower: if necessary, is the borrower willing and able to cooperate in getting the project back on track via loan restructuring or bringing in additional capital?

Managing Risk

If investigations reveal that the borrower or contractor does not have a good handle on the project, lenders may still be able to avoid foreclosure by introducing an additional element of risk management: owner’s representative services.

Owner’s Representative (OR) Services provide dedicated, hands-on experts who act as an extension of the project owner’s team to bring the project to completion. On distressed projects, communication between project owners, contractors and lenders often breaks down. An Owner’s Rep facilitates communication between all project parties and troubleshoots issues as they arise, ensuring that the project owner’s interests are protected as the project is completed.

While OR Services are typically engaged by the project owner/borrower, lenders on distressed projects may also engage these services or require borrowers to do so as loan terms permit, or as a condition of providing additional capital. Whether or not the cost can be passed on to the borrower, engaging an OR may be beneficial to a lender who is facing the likelihood of having to complete the project anyway.

Learn More about Dealing with Distressed Construction Projects

When construction projects exhibit signs of trouble, swift action is necessary to keep problems from escalating. Lenders should have a plan in place to evaluate distressed projects and work with borrowers to find mutually beneficial solutions that avoid foreclosure and allow the completion of the project. For lenders who want to learn more about this process, industry experts will discuss the topic of distressed assets in a free, upcoming webinar hosted by Partner Engineering and Science, Inc. Register for the webinar here.