Commercial Mortgage Insight

The Role Of The Lender's Consultant In Construction Projects

The lender's consultant should act as the technical eyes and ears during construction and help the lender reach the right business decisions.

BY ROBERT FEMENELLA

A large construction project is only 50% complete, but is three months behind schedule and way over budget. The lender rips into her consultant (sometimes referred to as the inspecting architect or engineer) demanding to know, "What's going on? How did this happen? Why did I bother to hire you?" These are good questions that deserve good answers.

It may be easier to define the role of the lender's consultant by what he is not rather than what he is.

The lender's consultant is not the design architect or engineer; he is not the construction manager nor the general contractor; he is not the owner nor the lender; he is not the project superintendent nor a trade foreman; he is not the building code official nor the testing lab. The consultant is not responsible for designing or building the project, nor is the consultant the decision-maker for the project.

So if the lender's consultant is not any of these things, then what is he? Ideally, the lender's consultant is a trained architect or engineer (preferably licensed) with extensive design and construction experience, who is knowledgeable enough about all aspects of the design, development, and construction processes to be able to keep the lender properly informed about the status of the project so that the lender can make intelligent funding and business decisions.

The consultant should be the lender's technical eyes and ears during the construction process. Keeping the lender properly informed means that the consultant needs to provide accurate, relevant information in a timely manner and in clear, understandable language.

Lenders need accurate, relevant information. Knowing that the shelving has been installed in 126 out of 337 apartments may be accurate, but not really relevant to the concerns of the lender. Knowing that the delivery of the kitchen cabinets was delayed due to a fire at the manufacturer's plant and the impact of that delay on the final project completion is relevant.

The importance of timeliness

Timeliness is also important. The lender would prefer to know as soon as possible if the completion date will not be met or if the budget is inadequate. The consultant should not be calling the lender two months before the final completion date and informing her that an additional three months is needed.

Delays in receiving relevant information may prevent the lender from making appropriate business decisions, or reduce the lender's options.

Understandable language is also important. For instance, compare the following statements:

"The general contractor's current buyouts have not yet been fully completed and those trades that have been bought out have exceeded initial expectations, but the final impact on the overall project budget cannot yet be exactly determined."
"Approximately 60% of the trades have been bought out. These show a total overrun of $500,000 leaving only $50,000 in remaining contingency. An additional $150,000 contingency is recommended at this time."

The consultant should not bury valuable information in a tangle of confusing prose.

Additionally, the consultant should be constantly revising and updating his opinion on the status of the project. A construction project is not a static process and as the project continues and circumstances change, the impact of these changes needs to be included in the consultant's report to the lender.

A project may have been on schedule for the first six months, but horrendous winter weather may have pushed the project back three weeks. Recent unforeseen field conditions or coordination problems may result in additional costs and delays.

What lenders should know

Now that we know how the consultant should present information to the lender, we need to know what type of information needs to be presented. Typically, lenders need to know about the scope, quality, development team, schedule, funding, and budget.

The scope of the project includes the overall parameters of the project including square footage, number of floors, number of apartments, quality level, etc. Design revisions are made in every construction project. Most of these changes are relatively insignificant and do not affect the overall scope or quality of the project. But some do.

Those that do, need to be brought to the lender's attention. Lenders are not only concerned with reductions in scope or quality (often referred to as "value engineering"), but also in upgrades which may increase costs and add time.

With regard to quality, the consultant needs to make sure that all appropriate tests, inspections, permits, approvals and field reports are made, and that the results are satisfactory. During his periodic field visits, the consultant must rely on his experience to make sure that the work being performed is in general conformance with accepted industry standards.

Included with the scope of the project, the consultant also needs to keep the lender informed about the status and effectiveness of the development team. The development team refers to the individuals and organizations that come together to design and build the project. They include the owner, architect and engineers and the general contractor.

Each member of the development team has certain responsibilities that are required for the successful completion of the project. These responsibilities change as the project progresses. If a member of the development team is not fulfilling their responsibilities, the project could suffer and the lender should be informed.

Typical problems with the development team include:

the re-assignment or resignation of key personnel,
reduction of personnel,
additional responsibilities assigned to key personnel which reduces their effectiveness, and
incompetence.

The construction schedule must be constantly re-evaluated by the consultant. The owner or the general contractor are responsible for updating the schedule.

The consultant needs to inform the lender of how the project is progressing, if the current schedule is realistic and if the anticipated completion date will be met. If the project is not going to be completed on time, the lender needs to have the consultant's opinion of the projected completion date.

Current requisition

The consultant must also review the current requisition to determine if the funds requested are in line with the work completed and material stored. The consultant must also determine if the various paperwork required by the lender for this particular project is properly submitted (subcontracts, change orders, lien waivers, bonds, etc.).

The monthly requisition is often seen as the focus of the consultant's work, but it is really only one of several equally important aspects.

The status of the hard cost budget is another area that the consultant must constantly re-evaluate to determine if the funds remaining are sufficient to complete the project.

How this evaluation is made varies from project to project (owner-builder, lump sum, cost plus with a guaranteed maximum price), but what does not vary is that the lender needs to know every month if the current hard cost budget is adequate, and if not, approximately what amount of additional funds will be required. The consultant's knowledge of all aspects of the project form the basis of this very important projection.

Lastly, the consultant cannot form proper opinions without certain information, and the borrower, architect, and general contractor need to cooperate with the consultant. Revised drawings need to be submitted, copies of subcontracts and change orders need to be sent, current schedules need to be presented, inspection reports need to be reviewed and relevant questions need to be answered.

If the consultant cannot obtain the information and documentation required, then the lender needs to be informed about this problem.

In summary, the role of the lender's consultant in the construction process is to ensure that the lender is constantly aware of the status of all aspects of the project as well as all actual and potential problems. If the consultant performs his role properly, the lender will be in a position to make the most appropriate business decisions with the widest range of options that will best protect her interests.

Robert Femenella is a licensed engineer and a senior vice president with Eckland Consultants Inc. of Deerfield, Ill. He has been providing construction monitoring and due diligence services to banks, lenders, and investors for over 15 years. He has extensive experience with all aspects of construction, especially in the analysis of hard cost budgets, and has given numerous construction-related seminars to a variety of clients. He is located at Eckland's New Jersey regional office and can be reached at (732) 283-7600.

This article was previously published in the May 2000 Issue of Commercial Mortgage Insight.