The “W” word is one that lenders would rather not utter. But the reality of the recent economic morass and its effect on uncompleted construction projects, and, therefore, their underlying loans, is that workouts are inevitable as more projects become troubled. Construction lending carries a considerable amount of risk. Distressed and troubled properties, of course, differ in the nature of their problems and, consequently, in the construction lender’s path to hopefully salvaging some portion of return. The reasons for the troubles during construction are myriad, including poor management and significant schedule extensions; inadequate contract documents (which can lead to a plethora of change orders and cost overruns); lack of control of the finances; inexperienced developers, contractors and subcontractors; undercapitalized developer; and; in some cases, blatant dishonesty. Each project and its problems are different and, therefore, the solution or path to recovery is likewise unique. If the lender chooses to take over the project, either by utilizing in-house workout expertise or an outside servicing agent, a construction consulting firm with workout experience is an essential team member.
The construction consultant’s basic responsibilities focus on brick and mortar issues, construction contracts, permits, and budgetary elements. Establishing where the project stands is the essential first step and involves physically observing the construction, determining its conformity to the contract documents, and, most importantly, establishing what it will cost to complete the construction so that the project can be brought to market. Merritt & Harris, Inc.’s Workout Group generally adheres to the following process when it is asked to assist a lender on completing a distressed or underperforming project:
In a recent actual case, Merritt & Harris, Inc.’s Workout Group was called in to assist a small bank with a problem construction loan. The project under construction was a multi-use building which was to contain residential units (condos), ground floor retail stores, and community facilities. At the point of the Workout Group’s involvement, the project had exceeded its budget, and any semblance of a schedule had been long abandoned. A major contributing factor to the problematic process was an inexperienced developer whose primary interest was an industrial company that he owned. In addition, many work stoppages had occurred due to building department violations (mostly regarding construction safety and the lack of a hoist – the building exceeded 75 ft. in height), and permitting problems. The lending bank had not retained a construction consultant to monitor the project.
The first order of business for the Workout Group was to tour the project to determine its existing condition and state of completion. Based on the information gained by this assessment, the group’s cost estimators were able to determine a cost to complete the work, which at that point was 25% higher than the original budget. Because the developer was a favored customer, the bank chose to work with him rather than foreclose on the property. The bank required that additional equity be injected into the project and increased the amount of its loan. At the Workout Group’s urging, an expediter was retained to deal with the building department issues. At the developer’s insistence, the general contractor was kept, as were most of the subs. The project continued with a new budget and revamped construction schedule while being monitored by the Workout Group’s project manager.
It would be good to report that all went well from that point on, but, alas, the bad habits of the developer and contractor were not cured. The work continued to drag on, not adhering to any schedule. As so often happens in these situations, the contractor and architect began to lose interest in the job, as the duration of the work was now approaching five years. The Workout Group’s project manager had to jump in as cheerleader and insist on regular meetings including the developer, general contractor, architect, and expediter. With much pushing, pulling, threatening, and pleading, the project was eventually completed.