How Lenders Can Minimize Risk in Their Construction Portfolios During Times of Economic Uncertainty

As a lender, you may not be able to control the external macroeconomic factors currently affecting the real estate industry–however, there are many factors you can manage to protect your projects in times of elevated risk. The following best practices will help you minimize risk in times of economic uncertainty to help keep your construction projects on track and within budget. 

Thoroughly vet construction contractors.

Replacing contractors on your construction projects can be costly, as they are unlikely to refund any money they’ve already been paid. In addition, any unsatisfactory work that was already completed may need to be redone. For these reasons, it’s important to have a process to properly vet contractors before bringing them on to a project. The process of vetting contractors typically begins by contacting their former clients to evaluate performance on past projects. You should prepare a detailed list of questions to ask regarding safety practices, timeliness, and quality control. Be sure to request photographs of finished projects, and if possible, visit past job sites to conduct a more thorough review of their work. It is also crucial to ensure that any potential contractors have the required up-to-date insurance and certifications and that their financial health is in good shape. Be especially cautious of contractors who don’t have a long track record and those with low prices that seem too good to be true.

Between making phone calls, sending emails, requesting documents, and visiting job sites, manually vetting contractors can be quite a bit of legwork. And, determining the trustworthiness of contractors who don’t have a proven track record can be an even greater challenge. ​​Built allows you to determine contractor eligibility to your lending guidelines in minutes. By integrating with national industry reporting firms, Built aggregates contractor data such as license status, insurance, past project performance, and credit profile to help you easily evaluate contractor capabilities and determine if they meet the scope of your project. And, it doesn’t stop at origination. With Built, you can continuously monitor the contractor’s status throughout the duration of a project.

Complete a plan & cost review.

Effective risk mitigation begins before shovels even hit the ground. Barring a crystal ball, plan & cost reviews are among the most effective ways to help you identify and address potential areas of risk on your construction projects before closing.

What is a plan & cost review?

A plan & cost review is a review of critical loan documents and information that helps forecast project timeline and cost. Plan & cost review is necessary for the pre-close process to help identify and address any unforeseen risks upfront. However, reviewing each project’s budgets, plans, appraisals, and contracts can be incredibly time-consuming and put a strain on your administrative teams. Built can help facilitate the process of reviewing each necessary document in the pre-close process and provides recommendations on any areas of concern before you fully fund the loan–ensuring all necessary checks, reviews, and inspections are completed and all documentation is in place so the project can be finished on time and within budget while maintaining compliance.

Pre-schedule regular onsite draw inspections.

Construction draw inspections fulfill two objectives: they ensure funds are being disbursed based on work that’s been completed and they serve as a lender’s primary method to monitor construction progress. However, progress inspections are often only facilitated when a draw is requested–meaning your ability to monitor construction progress is driven by draw requests. So, when draws aren’t requested, you’re essentially left in the dark. An effective way to mitigate this risk is by pre-scheduling regular onsite progress inspections every 30-45 days. Pre-scheduling onsite draw inspections not only puts you in control of monitoring project progress but also accelerates draws by consistently making funds available to the builder based on completed inspections–which means no more waiting for inspection results after a draw request. When money moves faster, projects can be completed quicker–reducing the window for risk.

How can lenders monitor projects between onsite inspections?

Remote project progress monitoring is an effective low-cost solution to fill the gaps between onsite inspections and enhance project visibility. Built’s Project Snapshot is a fast and secure remote progress monitoring solution that allows any individual associated with a construction project to capture geo-stamped photos and upload them directly into the Built platform at no additional cost. Pre-scheduled inspections supplemented with remote monitoring like Project Snapshot grants you constant visibility into your project–significantly reducing the probability of default. In fact, according to a report released by the FDIC, an increase from two to three project monitoring events every 100 days can reduce the probability of default by 72%.

Proactively monitor for key risk factors.

Even in the best of times, surprises can, and often do, occur that can cause project delays and cost key stakeholders a significant amount of money. In times of economic uncertainty, when factoring in rising material costs, supply shortages, and high interest rates, the likelihood of a contractor failing to pay their debts or a supplier filing a lien for not getting paid increases. Proactively monitoring for key risk factors is a highly effective way to stay on top of any issues that can negatively impact your construction project. 

Which risk factors should you prioritize?

• Contractor issues: Contractor issues such as credit delinquencies, federal tax liens, and lapses in licensure and insurance coverage all have the potential to derail even the most carefully planned projects. Even if you’re taking steps to vet contractors upfront, contractor issues often arise on projects after the acceptance phase. Monitoring your contractors via periodic assessments of their tax returns, public filings, balance sheets, income statements, and overall financial profile throughout the life of the project can help you catch contractor issues before they cause problems–significantly lessening the likelihood and severity of a loss. 
• Mechanics liens: Not only can mechanics liens delay progress–which is costly for everyone involved in the construction project–but they can also signify deeper payment issues on your projects that need to be addressed before they cause further problems. If a mechanics lien is filed, lenders should know the record type, parties involved, and lien amount to resolve disputes as efficiently as possible to reduce constraints in the draw process and maintain compliance. 

Unfortunately, many lenders aren’t monitoring their projects properly because facilitating these assessments manually is time-consuming and puts a major strain on administrative teams. Luckily, implementing a digital project monitoring solution can streamline this process–helping to mitigate risk by actively monitoring for contractor issues and involuntary liens and providing real-time risk alerts so you can take action quickly.

Order periodic title searches.

While digital lien monitoring is an effective way to identify active liens on a property, lien monitoring coverage can be sporadic, and refresh rates vary from county to county. Title searches are an effective way for lenders to avoid disbursing funds on projects with active liens–as they pull the most current lien and tax data available and can be performed anywhere, regardless of lien monitoring coverage.

What is a title search?

Similar to a background check conducted by an employer, a title search is a point-in-time review of the current state of that property’s title, intended to protect lenders against any hidden encumbrances that may affect the property, such as claims on the property. Title searches identify three primary areas related to the property: 

• Voluntary liens (i.e., mortgages) 
• Involuntary liens or judgments (i.e, mechanics liens and tax liens) 
• Property tax status (current or delinquent)  

A good rule of thumb is to order a new title search with each new draw. Additionally, some government-sponsored renovation programs require clear title searches before the final draw and project closeout.

How long does a title search take?

A typical title search can often take a week or longer, which leads to delayed draw turn times and friction between the lender and borrower. However, when using Built to facilitate title searches, lenders have seen average turn times of two days or less. And, once completed, searches are uploaded directly into Built’s platform for easy access. 

How to reduce the impact of risk on your construction projects

In times of economic uncertainty, you as a lender need to be more diligent than ever when mitigating risk on your construction projects. The best practices detailed above will help minimize the likelihood and severity of risk on your projects–however, these are only the bricks for which to build your house. The foundation is technology. Construction projects are far too complex for manual risk mitigation to be effective. When factoring in rising interest rates and inflation, technology is essential to protecting your projects, your money, and your business. 

Built Marketplace fundamentally changes the risk profiles associated with construction by combining best-in-class on-demand services with ongoing monitoring solutions to create the most robust digital risk mitigation program in the industry. With solutions ranging from fast, auditable remote inspections to daily lien and contractor monitoring with active risk alerts–Built Marketplace has you covered in the best and worst of times.

Are you ready to start protecting your projects? Click here to get started.