Did the contractor walk of the job over a dispute with your borrower? Did you get a call about a slow project and claimed Covid-19 as the reason? Is the “flip” now occupied and not really under construction?
What happens when you experience a borrower who no longer meet their obligations for your loan? Prior to March you would simply pick up the phone and offer the “project” to an existing borrower from the past, offer them to finance it and get the project over the finish line! Today is a whole new world! How is your Asset Management group organized? You don’t have one?? Well you have a few options on how to get this Note or REO off your books. Your first option and quickest is sell the Non-Performing Loan (NPL)! An NPL on a partially built home is going to be a painful trade because your PLTV (Peak Loan to Value) is the highest during the demo and early construction phase. Second is the Deed in Lieu (DIL) where you negotiate with the borrower to hand over the keys and you now have an REO without the foreclosure process, time and fees. The last option is REO! Hold on because it can take a while, and with state governments closed it is even longer, and will be costly.
So three options for loans that have gone bad. This is where having experienced Asset Management support by your side is required. When that contractor walks off the job, you need to try your best to have them make up with your borrower, interject yourself in the middle of the process, the Scope of Work and Bid are from that contractor and you approved the loan based on that fact. If they don’t finish, then a new contractor may not do the same work for the same price. Did you underwrite the project/borrower to assume change orders and cost over runs? If not, you could experience delays, costs the borrower may not be able to absorb, and more importantly a project a borrower won’t or can’t finish.
If it doesn’t work with negotiations with the borrower and contractor and you get a property back how you can minimize the loss on the project? You need to look to your Asset Management support and walk through the same process you did to initially underwrite the project. Grab your appraisal, review it or get a new one or other market intelligence like https://richervalues.com/that will help you determine “if” you want to finish the project or sell it “as is” to another investor. If you decide that completion of a project is the best course of action, then you need to do all the things required to manage the project like a borrower or contractor must do daily. Do you have the right staff for this part of the process? If not, what do you do?
Here are some things that will guide you in the right direction: Find a licensed and insured contractor and get a scope of work and bid. Then you need to do compare it to your project feasibility report or generate a Cost to Complete (CTC) report so you have an idea if the bid is in line with the market. Low bid is not the right bid! Once you determine the contractor is qualified, gather all their insurance and license documentation and validate the bid you can begin the construction process. Finishing the process requires attention, communication and site visits so be prepared to spend a lot of time on the asset management. You will need to manage the draw process or fund control! You will need to have all the lien release forms for that state, manage them, ensure they are correct and validate the invoices the contractor submitted to make sure the materials are used for your job. Then you must go out and inspect the project. Who will do that for you? A realtor? The contractor? A Guy? – It is critical that you don’t over fund draws and more importantly ensure the work is “in place” before the contractor receives funds.
Remember that construction lending is more than a loan process and busted construction projects will happen like any other loan that you originate. The key to minimizing losses is due good due diligence up front on the contractor and project and scope. Manage the fund control process tightly and always trust but inspect. Once a wire hits an account it is gone so make sure you know what you are paying for before it is too late. If you don’t do all the step-in construction loan management, you should! An inspection is not risk management and trusting the borrower or contractor is not risk management. If you do not have the staff to do it hire a third part construction loan management company like www.ThinkCFSI.comwho will guide you through the process? Let your underwriters manage credit risk and let CFSI manage construction risk!
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 Managementis a leading provider of construction portfolio management solutions, helping lenders reduce risk related to construction projects nationwide.