Evaluating Proposed New Construction
A lender should only proceed with a loan commitment that involves new construction with the assistance of a technical representative. The definition of new construction includes the following:
- Development and construction of a new property in its entirety, including site work and building shell construction.
- Construction of major building components, such as shell construction of additions.
- Installation or replacement of major mechanical or electrical systems.
- Major alterations to site configurations and amenities.
Shell construction is defined as construction of base building components, not including special finishes and systems, to accommodate the needs of tenants. Normally a project that involves only the installation of interior tenant finishes can be overseen by the loan originator in conjunction with loan servicing personnel.
New construction carries with it many risks. If the project is not "structured for success" it can fail. To determine this, it is important for the technical representative to make a thorough review of the scope of the work to be performed, and of the organization and credentials of the design and construction teams who will be managing the project. To be a success, the project must be appropriate (investment grade real estate) and it must be completed as originally planned and as envisioned by the investment decision-makers. To do this it must be properly conceived, designed, constructed, and completed on schedule and on budget.
Prior to making any commitments or agreements, the technical representative should review the following items:
- The proposed scope of the work to be performed.
- The status of the project (i.e., how far into the design/construction process it has progressed to date).
- The proposed budget for the work and the origin of the budget (i.e., is the latest budget based on an engineer’s estimate or construction bids?).
- The qualifications and experience of the professionals involved in designing the project and in managing the new construction.
- The format of the construction documents to be used and the procedures to be followed during construction.
- The construction schedule and the schedule management methods to be used during construction.
Reviewing the Proposed Scope of Work. The proposed scope of work should be reviewed sufficiently to determine that the project would be investment grade real estate. If the construction documents, including plans and specifications, have been completed, these should be thoroughly reviewed, as described later in this Chapter. It is possible, early in the loan process when new construction is involved, that only conceptual plans are available. If this is the case, it is important to ascertain and include within the wording of the proposed commitment language, the proposed materials of construction, major system components and general details of construction, along with critical dimensional data (i.e., floor areas, number of parking spaces, etc.).
Understanding the status of the project. A project is in the "conceptual stage" when it is only an idea, without legal status within the community. A lender should never make a commitment to fund a project that is in the conceptual stage.
Before requesting any involvement from the technical representative, the loan originator should determine that the project has received, as a minimum, "site plan approval." For the project to obtain site plan approval, the developer will have expended considerable effort. This involves conducting soil borings, preparing detailed conceptual building plans (usually preliminary architectural plan view and elevation drawings, most often in conjunction with a structural engineer), preparing preliminary site plans, including the design of connections to public utilities, driveway access and parking layouts. The developer then presents his project before the various local governing bodies with jurisdiction, obtaining approvals along the way. These include governing bodies controlling zoning, water, wastewater & other public utilities, public health, roads and streets, and historic commissions. The process most often involves public notices to abutters and public hearings. When the requirements of each governing group have been met, the site is granted site plan approval and the project has cleared the first hurdle in securing legal status within the community. This gives the owner the right to construct a defined project (i.e., an apartment building with a certain number of dwelling units, floors, prescribed floor areas, a particular facade and positioned on the property as approved).
At this point, with site plan approval, the "concept of the project" has been accepted and approved by the community and the technical representative should become involved and participate in the remainder of the construction plan development process along with the owner’s project team. With site plan approval, a lender can make a commitment to the project. The commitment must define the work in as much detail as possible including materials and details of construction, budget (with appropriate contingencies), and schedules. The commitment should spell out the role of the technical representative during the remainder of the plan development process and through construction completion. This would include periodic review of progress construction documents as they are developed, and the review and approval of final construction documents. The commitment must outline inspection procedures during construction by the designers of record and by the lender’s technical representative.
The next step in the plan development process requires obtaining a building permit. This requires completing final construction documents including plans & specifications. Once these are completed, the developer submits them to the community building inspector for review and approval, and a building permit is issued. At this point construction can begin. Most often, a lender becomes involved in a construction project after a developer has obtained a building permit. Making a loan commitment prior to obtaining a building permit involves a higher degree of risk, primarily regarding construction scheduling and budget. If the project involves major construction, a lender should never get involved in making a loan commitment prior to the developer obtaining a building permit, particularly with forward commitments.
