In Malcolm Gladwell’s book, Outliers, he discusses the fact that most airline accidents can be traced back to seven errors which end with the event. Problem construction loans are a result of a similar chain of events. The symptoms and solutions can be readily observed but are not often conveyed properly to the lender which can lead to both financial and client relationship issues.
As it pertains to a construction loan in progress regardless of its type, residential or commercial, or its size, there are two distinct operational points. The first is the field inspection. During this process, a third party who is generally hired by the bank is assessing the project and advising the bank of its status. The second operation point follows the third-party inspection process and involves the actual process of the funding from within the institution. This article highlights the field inspection element of the lending process also typically referred to as the construction draw inspection.
Let’s begin with the typical work flow associated with a third party conducting a construction draw inspection to recommend the funding of a pay application. The process begins with the receipt of the actual application for payment from either the borrower, contractor or the bank. This is followed by a review of the documents submitted and a brief review of any previously submitted information. Once an understanding is gained form this information analysis, the third-party inspector then visits the project and submits an opinion regarding accuracy of the pay application and recommends funding accordingly. Essentially the four steps are; Receipt, Review, Inspect, Advise.
Step 1: Receipt
What can possibly go wrong with the receipt process? A number of things. In the absence of a standard protocol, transmission of the pay application to the inspector can fall through the cracks resulting in delayed payments which in turn may impact the construction schedule. The wrong collateral may be referenced in the case of large builder lines or revolving lines of credit which can in turn delay the process and result in unnecessary re-inspection fees. There may be a break in the delivery chain such as a critical team member being absent unbeknownst to the balance of the team.
Step 2: Review
During the review portion of the process, the burden falls on the third party. It is at this stage of the inspection the third-party inspector must thoroughly understand the elements of the pay application. The inspector must start by verifying the previous draw has been accurately reflected with the current draw amount. Following, the inspector must determine if the draw is inclusive of elements which require further attention such as change orders, stored materials, deposits, allowances, or retainage anomalies. Prior to visiting the project these considerations must be properly vetted and understood to complete an accurate inspection.
Step 3: Inspect
The meat and potatoes of this process is the inspection. Assuming the review elements have been considered, it is this phase which documents site progress. An institution must ensure the inspector is both qualified to look at the project and is not limited by technology to conduct and offer site specific observations. In some cases, simple phone apps are being used to provide a controlled limited project snapshot. It is important for an inspector to review many aspects of a project depending on its state of completion. Observations of manpower, municipal inspection comments, quality of work, progress of phases, site conditions, and security are all aspects which can be leading indicators of troubles to follow.
Step 4: Advise
In this stage, the third party must communicate with the bank their observations and opinions. The bank is typically leaning into the inspector at this point and indirectly so is the client. The clear and concise communication of the project’s status is paramount. Using a standardized format allows the bank to quickly and readily scan a report and make the proper funding decision If the inspector does not articulate the issues clearly, the funding decision may affect the value of the collateral. In the absence of an overall clear project understanding and confidence in the funding decision, a project can begin to slip into territory which can be difficult to right.
It is essential for a bank to utilize a pre-qualified inspection firm that is familiar with the specific construction project. A protocol should be established in the beginning which provides a standardized playing field and have flexibility in their reporting technology to address the many atypical conditions which can impact the loan. By following these simple operational steps above can help ensure your next construction project will be a success given any market condition.
CCDI provides comprehensive construction draw inspection services through in-house professional employees. We guarantee an immediate turnaround of your pay applications regardless of their location. To learn more about our services, please visit us at www.ccdiinc.com.