Four Qualities Lenders Look for in General Contractors When Assessing Construction Risk
Lenders are particularly diligent in underwriting loans for construction projects.
There is good reason for this level of diligence. Since so many factors can undermine a development or redevelopment project, construction tends to be one of the riskiest areas of commercial real estate lending. Lenders are concerned about any risks that could impact the costs or timing associated with a construction project because the underwriting on a construction loan is related to both factors.
Qualities in the general contractors hired for construction projects are among the factors that can dramatically impact risk. By taking necessary steps to demonstrate a high level of integrity, general contractors can ensure that their projects come to fruition and they maintain a strong reputation in the field.
There are four essential qualities lenders look for in general contractors when assessing risk in construction projects.
1. Document Accuracy
The saying goes “prior planning prevents poor performance.” General contractors who provide lenders with accurate, detailed documents provide the lender with comfort about the extent of prior planning that has occurred and help facilitate the construction process.
These documents include schedules, environmental assessment reports, executed contracts, due diligence reports, a budget that accounts for all subcontractors (architects and designers of record, engineers and others) and more.
Lenders especially like to see accurate and thorough documents in the preconstruction phase of a project because these documents can alert the financial institution to potential construction-related risks.
Conversely, general contractors with incomplete or inaccurate documents introduce a greater level of risk to the process and may even prevent lenders from green-lighting loan transactions for those projects.
2. Responsiveness to Questions
When a project is about to close, lenders are likely to have questions for general contractors that must be answered in a relatively short time frame—typically, 5 to 10 business days after a risk assessment report has been issued. Contractors who are responsive to those questions can decrease perceived risk and help projects move forward.
Questions at this point usually involve documents that are missing, contain errors or aren’t signed. Perhaps there is a discrepancy involving dates of execution or miscoordination between the budget and architectural drawings.
General contractors who communicate readily with lenders and their agents to clarify or clean up these issues are assisting the project stakeholders in acquiring their loans. Those who are unresponsive or evasive muddy the process and increase risk, which could result in lenders rejecting loan applications for those projects.
3.Honesty
In any business, people are as good as their word, and construction is no exception. General contractors who are open and upfront; provide an accurate schedule and budget that clearly list: inclusions and exclusions, lien waivers and subcontractor responsibilities; and convey a high level of honesty engender trust from the stakeholders who hire them as well as construction lenders. Keeping projects clean in this manner is the best way to finish on time and on budget—and to develop relationships for future projects.
If a general contractor is dishonest or has structured a bid to allow for ambiguity and change orders down the road, lenders will discover these actions and consider them an increased risk for the project, which could undermine the ability to obtain financing for the project or future projects involving that general contractor.
4. Focus on Their Area of Expertise
General contractors who develop an expertise in a particular area of commercial real estate construction should be cautious about expanding into different product types.
Each product category in the CRE industry is a completely different animal from the others, and experience in one asset class does not necessarily translate to another. A background in multifamily construction projects is not the same as a background in medical office building construction projects. A lack of experience with a specific type of construction is a red flag to lenders for increased risk.
Fortunately, there are plenty of construction projects available within nearly every area of proficiency in commercial real estate, which presents many opportunities for general contractors to fill their plate in their own wheelhouse and be known in the industry as experts in that specialty.
Construction projects as a whole garner considerable scrutiny from lenders regarding risk. General contractors can help reduce assessed risk for these projects by presenting accurate and thorough documents, being responsive to follow-up questions, being honest and remaining within their area of expertise. Having these four essential qualities will help owners and developers close loan transactions and move projects forward while reducing risk for their lenders in the process.