• Contract Language: When dealing with unprecedented market volatility, being proactive is the best solution. Current industry practices are trending toward a fair and equitable share of cost increases that are out of the control of project teams. Inserting language into construction contracts that dictates what happens in the event of an unexpected cost increase and who will be responsible for the cost is of utmost importance. This language should also include a cost threshold (i.e., dollar amount or percentage of contract value) that must be reached prior to an equitable sharing of the risk. Not only should the contract include explicit language regarding cost increases, but it should also address potential time increases as well as provide a clear definition of force majeure. • Thorough Review of the Budget: After review and approval of the contract terms and conditions, the next step is to thoroughly review the project budget. Gone are the days of using historical costs as a basis for budgeting or creating guaranteed maximum contracts. Construction costs are evolving so rapidly that the historical cost method is no longer accurate. The budget should be comprised of true and current (within 30 days) market pricing, backed up with supporting documentation from subcontractors and vendors. Overall project budgets should be vetted against recently completed projects of similar size, scope and location. In addition to the standard evaluation of the overall cost, the budget should be analyzed on a line-item basis, comparing itemized work scopes to similar projects in a specific market. Due to the fluidity of the market, this additional layer of cost evaluation often requires the assistance of a third-party cost consultant. • Procurement Process: Gaining a deep understanding of the project team’s procurement process has recently taken on greater importance during the underwriting phase. Understanding the intended purchasing strategy sheds light on multiple aspects of the project including the following: the number of outstanding subcontracts, the potential for stored materials, the required material deposits and even anticipated material lead times. To gain this understanding conversations must be held with the project team regarding their intended timing and methods for project purchasing and relationship with the market. It is important to note – as a lender, it is wise not to dictate the procurement process, as this would encroach on a borrower’s means and methods, which can lead to placing the undue risk on a lender. • Tying Loan Terms & Contract Terms Together: The final and most important step is to leverage the loan terms in concert with the construction contract. As simple as this sounds, this final step seems to be the one most often missed or overlooked prior to closing. Post-Closing Once the loan is closed, it is not safe to assume that a well-structured deal will simply run itself and stay out of trouble. Monitoring the progress of the project is equally important to track project metrics and report pending or looming issues. For without timely information, the lenders run the risk of receiving untimely “surprises” that can potentially derail a project or prevent the lender from making timely business decisions. The second piece of the risk mitigation solution includes monthly monitoring of each CRE loan. Monitoring includes employing a third-party consultant to visit each site monthly for reporting on the following: • Project Cost: Is the project tracking on the original budget? Are proposed cost changes warranted and Continued from page 23 With 20% of the construction workforce over the age of 55 and the number of workers between the ages of 25-54 decreasing by 8% over the past decade, there are concerns over how the age of the workforce will affect the industry long term. www.coloradobankers.org 24
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