Construction loans have inherent risks that need continuous control to ensure each project’s success and profitability. Some risks associated with construction lending include project reporting failure, not protecting your first lien right, failure to complete a project within the interim construction period, and low or no contingency budget.
Risk mitigation allows you to control and stop these risks from turning into problems that can adversely affect business operations and negatively impact your bottom line. To successfully mitigate risks, you need to create risk avoidance measures, analyze your risks, come up with ways to reduce them, transfer the risks to a third party, and accept the possibility of risks occurring. Below are tips for mitigating risk across a construction loan portfolio.
1. Independent project review
Third-party reviews aim to assess a project’s overall funding sufficiency, ensure appropriate allocation of funds across line items, and sufficient detail verification to inform progress or draw inspections post-closing. Subcontract the review process to a skilled and experienced partner like Northwest Construction Control to mitigate risk exposure, ensure compliance, and streamline your process.
2. Pre-closing builder and budget due diligence
To satisfactorily mitigate risks, begin the risk management process before the project starts. Evaluate the contractor and carry out a thorough project budget cost review for feasibility validation. Using the best practices, ascertain the contractor’s financial stability and credentials before you accept them as worthy of working with. Additionally, ensure that the builder has the proper certifications, licenses, and project insurance.
3. Pay extra attention to inactive loans
As a lender, you want projects to start and continue to completion on time. Technology has made it possible to run a stale loans report on your construction portfolio to identify any loans with no draw or inspection activity over a particular period. Confirming the status of any stagnant projects will help you mitigate risks that might otherwise heavily cost you in the future.
4. Ensure appropriate insurance coverage
Since construction loans are short-term, high risk, and margin, ensuring that active commercial builders have verifiable insurance policies and appropriate documents for every project will help you mitigate construction risks. Getting involved in a project without a valid insurance policy will expose you to unnecessary risks. Use technology to automate and capture and track insurance policies and documents for when coverage lapses or records go missing.
5. Order regular draw inspections
Ordering draw inspections will help you ascertain that all work items and materials in the draw request are, in fact, in place. This also enables you to determine appropriate funds release. Inspections are meant to lower risks while ensuring that all the money you lend goes directly into the collateral.
6. Stay in the first position with lien waivers and releases
If your draw process is impacted by more rigid statutory mechanic’s lien laws that you have to navigate, collect the appropriate lien releases and potentially get a title date down endorsement with each law to maintain the first position. To ease the lien collection, provide the builder with a simple way to upload lien releases when they request draws instead of leaving everything up to them.
Construction loan portfolio risks can be expensive if not adequately mitigated. These tips will help you reduce risk across your construction loan portfolio.