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CRE Finance World, Autumn 2012

Recent Developments in Construction Lending Risk Mitigation: Expose the Myths to Reduce the Risks eliminating the general contractor role entirely2. The problem with Myth #3: The right to review contracts, change orders, and other this arrangement is that the construction manager is now responsible administrative documents provides the lender and their consultant for work performance, while the risk of non-performance may be an unbiased view of construction accounting and job administration. shared with the owner. This is a change from the traditional general contractor arrangement. The construction management agreement Reality: Parties that control the flow of information can potentially may assign the risk of subcontract default and time delays to the sway the judgment of those of the receiving end of that informa- owner. The owner may even execute subcontracts and essentially tion. This often means that a construction lender that operates in a hold all financial risk, while the construction manager acts as typical lending role, may be forced to form limited judgments based an enhanced owner’s agent, with broad responsibilities — even on only those documents the owner or the contractor is willing to absolute project control – but without meaningful performance share. An owner/borrower may be reluctant or even unwilling to obligations tied to budget, schedule or workmanship. share bad news, such as pending cost increases, scope of work disputes, pending design changes, etc. Even a well-intentioned Options: While many owners may prefer a construction management owner/borrower may delay bad news in the vain hope of a quiet agreement over a traditional general contracting agreement due to and unobtrusive solution. Let’s face it: fear of disrupting the steady perceived lower costs and greater control, this arrangement does flow of money from the lender can cause some developers and not necessarily benefit the lender. If the project is to be delivered by contractors to withhold bad news. a construction management contract, the lender needs to understand the role and risk position of the construction manager. The ability to independently identify problems despite silence or even denial at the job site is a critical task of the construction lender, “When staring down a project What construction and one of the most valuable skills of the lender’s construction going south, many lenders have manager role best consultant. Unfortunately, while the lender’s consultant should be been troubled by the unpleasant serves the lender? As expected to ferret out construction issues visible in the field or realization that it is difficult a general rule, if the inferred within documents, it is difficult for a consultant to discover to identify potential issues lender is comfortable construction problems if the owner and contractor systematically before they reach the critical with the development withhold information. crisis stage.” experience of their owner/borrower, a Options: It is naïve of a construction lender to evaluate risk solely construction manager on the information provided by their borrower. The lender needs under a GMP contract direct, unfiltered and unbiased access to project information, and should provide adequate budget projection, providing the contract there are ways to get that without relying on the borrower: details are satisfactory. This arrangement typically provides the owner some project control and favors competitive pricing. •Mandate that the lender’s consultant attend regular owner/architect/ contractor meetings to not only monitor progress but also get a Alternatively, if there is less confidence in the owner/borrower, sense of the project difficulties and festering issues. Attendance then the lender may prefer project administration by a traditional by the lender’s consultant should not be misinterpreted as general contractor. In this case both risk and responsibility are management; the consultant is there only to listen. confined to a single entity — the general contractor. This traditional form of construction delivery often holds the least budget risk. Of •Provide the consultant unfettered access to contractors and course, responsibility should only be assigned to a general con- contract documents. This allows the consultant to hear from tractor who has proven competency, experienced staff, adequate the source of a problem, rather then getting second or third financial strength, and acceptable payment and performance hand summaries. bonds in place. A publication of Autumn issue 2012 sponsored by CRE Finance World Autumn 2012 41


CRE Finance World, Autumn 2012
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