Managing Lender Risk with Construction Loan Monitoring

Mon Aug 27, 2018 at 11:00 AM

When it comes to commercial loans, lenders face unique challenges.

Risk mitigation is the number one concern for lenders, and there are steps they can take to minimize their risk. Construction loan monitoring (CLM), while not a formal requirement, is standard practice for a majority of lenders. CLM is the process of tracking the legitimacy and progress of construction projects funded by a loan. Typically, a lender approves a developer for a construction loan, then hires a third party to observe and report on the construction process.

As lenders’ businesses focus on the financial aspects of construction, not the construction itself, they hire a CLM professional, a project manager, to be their eyes and ears on the project. A CLM project manager is a trained and experienced construction professional, typically with a degree in civil or construction engineering, construction management, or the like. Project managers develop excellent technical and people skills in order to provide the construction expertise needed and encourage positive interactions between all parties involved. The best CLM teams balance prioritizing client needs with those of any other involved parties to provide the smoothest experience and most successful project outcome possible. For all parties, however, a clear understanding of lender expectations for disbursement of loans is key in achieving the best project outcomes.

In the past, front-loading a loan, or disbursing the entire loan at the beginning of the project, was commonplace. However, this practice increased lender risk, as it holds loan recipients less accountable to maintain agreed-upon project plans. Now the common practice is to release loan disbursements on a schedule. Disbursements are dependent on the developer meeting certain milestones—project targets based on a predetermined schedule—and providing proper documentation. The project manager acts as a liaison, working with the developer to track the project schedule and required documentation, and ensuring the client’s money is directed to its intended purpose. Tracking project details reassures lenders that their investment will be profitable, concluding on time and on budget.

EBI Consulting performs CLM work for both commercial and private lenders. Most commercial lenders are banks, whereas private lenders can be smaller companies, individual property investors, or owners. Commercial lenders usually leverage a traditional CLM scope of work, including frequent assessments and reports, while private lenders tend to require more in-depth CLM scopes, as they have more risk involved. In both instances, EBI reports the project’s progression to the lender and advises on the next loan disbursement.

For commercial lenders, the CLM scope of work will typically include:

  • A review of project documents including plans, contracts, and budgets (often prior to signing off on the loan), and a full report of any relevant conclusions to keep the client informed
  • Field monitoring and monthly detailed reports on project status, including draw requests if applicable
  • Collaboration with the client on project scope, milestones, and expectations
  • Monitoring of code compliance and tracking construction materials

Private lenders, on the other hand, may get involved with higher risk projects or clients. While often less restrained by strict corporate policies than their commercial counterparts, they require greater attention to detail both up front and throughout the construction process. Their higher risk tolerance allows for greater leeway in how funds are disbursed and for what project milestones. However, they may involve other lenders or investors with their own requirements, and this can make the CLM process more complex. These investors or lenders may have a longer-term interest in the project beyond the construction loan term, and, if less familiar with construction lending, may require more consulting regarding industry standard terms for disbursement.

Over the course of a recent construction project, EBI had the opportunity to work with lender and developer partners through a difficult situation. EBI’s CLM team was able to help craft a mutually beneficial solution for all parties involved.


Collaboration: the Key to Success

EBI Consulting was hired by a private lender in 2016 to monitor the development of a 3-building resort on a small island off the coast of the US. The site construction was halted in 2008 due to the recession and after years sitting idle, a new developer purchased the land. The lender hired EBI to work directly with the developer to track project costs, milestones, materials, documentation, and project closeout.


Project Beginnings

The project started as a standard CLM contract: a Construction Plan and Cost Report (CPCR) followed by monthly Construction Monitoring Reports (CMRs). A CPCR entails a full assessment of project documentation including contracts, permits, approvals, budgets, construction plans, and other requisite documents. The project manager then informs the lender or investor of any concerns or discrepancies prior to the project start. In some cases, a CPCR takes place prior to closing on a loan so all parties involved have the opportunity to make alterations to the project scope if necessary.

After successfully performing the CPCR, EBI conducted monthly CMRs to keep the lender updated on the project progression and to help them determine whether to fund the next loan disbursement. A typical CMR consists of field assessments and extensive reporting of the project progression for the lender’s review. The project manager performing the assessment keeps track of documents such as materials lists, change orders, plans, specifications, and construction contracts, and ensures everything matches the project agreement.


Trusted Consultation

After several months of construction, the developer experienced issues with the general contractor regarding cost ambiguities, scheduling challenges, and missed milestones. While these problems can be common in the construction industry, the developer concluded that the issues with the general contractor were impeding the success of the project to the point that it was decided to take the significant step of removing them from the project.

EBI was informed of the developer’s decision by the lender and stepped in as an advisor and liaison to work with both the lender and the developer to:

  • Help both parties navigate the removal of the general contractor,
  • Advise the lender on ramifications to the project and how their interest might be impacted by a temporary suspension of work
  • Collaboratively develop project milestones through the transition period as the developer took over as general contractor

EBI facilitated communication among the parties, working alongside lender and developer to provide the best possible solution for all the parties involved.

It was agreed that the developer would take charge of the project, overseeing the subcontractors. Fortunately, all but two subcontractors remained on the project. A construction manager was also brought in to manage the day to day operations on site. Although the lender suspended disbursements during the transition period, EBI continued to make regular site visits while reviewing and advising on the new project framework, revised project documentation, milestones, and new schedules. EBI also compiled CMRs from the four-month-long transition period into one report for the ease of the lender, who began disbursing the loan proceeds after the developer met certain transition period milestones.


Back on Track

The new framework proved successful. The first two buildings were finished on their revised completion date of June 1st, 2018, and the last building is on schedule for completion in the fall of 2018. The completed buildings are already fully utilized and occupied by resort owners. Completing the project on time and on budget is crucial to every developer and lender, and in this case, it gave them the opportunity to begin generating revenue through regular resort operation.

Despite some challenges, this project became a success due in large part to the collaborative efforts of the lender and developer, as well as through EBI’s project coordination. Once the project framework was reworked, EBI’s accurate and detailed reports gave the client confidence in releasing each loan disbursement, allowing the developer to move through each phase of the project and remain on schedule with ease.

EBI's diligent CLM professionals were able to navigate the project hurdles and effectively smooth any difficulties between the interested parties. The experienced and meticulous field assessors on the project were able to ensure the developer’s compliance with the lender’s project milestones and reassure the lender that the loan provided would perform as intended. EBI’s collaboration with both parties became a valuable resource and greatly contributed to the project’s success.


Experience Exceptional Service with EBI

EBI Consulting’s skilled CLM project managers helped the developer formulate a plan that met the needs of the project while focusing on and ensuring that the client’s goals were met. In this particular project, EBI’s CLM professionals adapted to the staff change, advised on the new project framework, and facilitated the continuing relationship between the lender and developer. The client was so pleased with the outcome that EBI has been hired to work on several ensuing complex projects.

This project stands as a testament to EBI’s flexibility and adaptability to any situation while still delivering on client goals. Past clients have experienced the benefits of our knowledgeable professionals and quality reporting and continue to rely on EBI for future projects. EBI’s project requirements are tailored to the needs of each client to ensure the most efficient path possible in achieving our client’s goals. The CLM team, upon client request, can also step into delicate situations as a trusted advisor. As an objective third party, our team can often see the most beneficial solutions that will serve all parties involved in your project.


About the Author

Ed Colaprete, Program Manager, Construction Loan Monitoring

Mr. Colaprete has 28 years of experience in the architecture and construction industries. He has spent the last 21 years performing due diligence assessments, surveys, construction consulting, and construction monitoring in the real estate services sector. Mr. Colaprete has completed hundreds of property condition assessments and has overseen and consulted on hundreds of millions of dollars’ worth of construction projects. For the last five years, his primary focus has been construction due diligence including in-depth assessments with acquisition clients, construction plan and cost reviews, and construction loan monitoring assessments.

Clients have come to rely on Mr. Colaprete to address complex building issues and provide a clear assessment of the risk associated with construction projects. His project experience covers all the main commercial building types including office, industrial, warehouse, retail, multi-family, hospitality, and mixed-use.