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Join Justin Baker from US Bancorp CDC and Andrew Koelbl from New Market Support Company as they discuss construction industry trends, pre-closing best practices, post-closing best practices, and typical construction draw package requirements. Learn about booming markets, material/equipment/labor costs, potential risks/defaults, and more.
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Construction Industry Trendsand Best Practices forUnderwriting / Disbursement Presented by: Justin Baker (US Bancorp CDC) Andrew Koelbl (New Market Support Company)
PLAN for today’s CCML Roundtable: • Construction Industry Trends (Justin Baker) • Pre-Closing Best Practices (Andrew Koelbl) • Post-Closing Best Practices (Justin & Andy) • Typical Construction Draw Package Requirements • Potential Risks / Defaults and How to Address
Construction Industry Trends: • Booming Markets – Lots of work! • What markets have the most construction activity? • Material, Equipment, and Labor Costs: • What sort of trends exist related to construction costs? • Is it true that lumber prices are expected to increase? • Labor Shortages: • Why do Labor Shortages exist? How may this impact a project? • Other Industry Trends: • i.e. Minority Participation, Union Strength, etc.
Booming Markets – Lots of work! • What markets have the most construction activity? • There is lots of work taking place all over the country! • Cities (a few examples) • i.e. San Francisco, Nashville, Austin, Denver, Minneapolis • States (a few examples) • i.e. New York, California, Texas, Florida, Colorado, Minnesota • Urban vs. Suburban • Nationally, construction in urban areas has outpaced suburbs
Material, Equipment, & Labor Costs: • Construction Costs (general) • Construction costs have increased gradually in recent years. • Materials • Material costs seem to be ticking up slowly (i.e. 2%) per year. • Equipment • Growth rate has been slow (i.e. 1%) and is expected to remain flat. • Labor Costs • Labor expenses have increased at a higher rate (i.e. 3-4%) per year.
What’s going on with Lumber prices? • Tariffs on Canadian Lumber: • Trump administration recently announced plans to impose tariffs of between 3% and 24% on most Canadian lumber. • Why is the U.S. imposing these tariffs? • The U.S. Commerce Department recently determined that Canada had been improperly subsidizing the sale of softwood lumber products to the United States. • What type of impact will this have on construction costs? • Canadian lumber makes up approximately 30% of the U.S. market. • A study last year conducted by the National Association of Home Builders found that a 15% tariff would increase new home prices by 4.2% and cost 4,666 full time jobs.
Impact of Labor Shortages: • Why do Labor Shortages exist? • The recession impacted the construction industry more than others. • Many skilled workers/craftsman left the industry to find stable work. • In recent years, there has been a lack of vocational education. • Due to tight immigration policies, there are fewer international workers. • What types of trades are experiencing labor shortages? • Skilled Trades (i.e. Mechanical, Electrical, Plumbing) • How do Labor Shortages impact construction activity? • Cost overruns – Labor costs have been increasing at a faster rate. • Construction delays – Subcontractors are more likely to fall behind schedule and/or leave the jobsite for higher paying work elsewhere.
OTHER Industry Trends: • Minority Participation: • There is both a necessity and a strong desire to increase participation from minority and/or women owned businesses. • Union Strength (varies State-by-State): • In general, Union membership has declined in recent years. • Strong Unions: i.e. New York, Alaska, Hawaii, California, Illinois • Weaker Unions: i.e. North Carolina, South Carolina, Utah • Concern re: industry downturn in the next 18 months? • Some industry professionals are “cautiously optimistic” while others believe that we will see another market downturn in the near future.
Pre-Closing Best Practices: • Budget Review • Identify which line items are estimates (moving targets) and which are under contract • Require Plan and Cost Review from third party inspector and compare to budget • Make sure legal costs estimates are being monitored as closing approaches to identify potential cost overruns • Require both a soft cost and hard cost contingency. The amount varies per deal and risk • Risk Factors affecting contingency include GC strength, Owners Rep/Construction Consultant, Third Party Inspector, Type of General Contract, FF&E, etc….
Pre-Closing Best Practices: (cont.) • General Contractor Due Diligence • Financial Analysis of the GC • Payment and Performance Bond • Look into other projects GC has performed • Identify Type of contract (GMP, Cost Plus, etc…) • Stored material provisions and proof of insurance requirements • Timing of Permits • Change Order Threshold’s- what amounts require an approval from lenders
Pre-Closing Best Practices: (cont.) • Closing Draw Review • Suggested to identify a “cut-off” date so review is not put together through piece mail • Sources and Uses- get the borrower used to forms to be used post-closing • Soft Cost reconciliation spreadsheet • Try to ensure the closing draw correlates with the financial model • Pre-Closing Discussion • Set up a call with CDE’s, Disbursement Agent, and the borrower contact who will be responsible for submitting draw requests post-close • Make sure Borrower is familiar with approval periods, draw documentation, funding process
What are the “typical” Construction Draw Package Requirements? • Cover Letter (preferred but not required) • Draw Payment Application (AIA G702) • Continuation Sheet / Schedule of Values (AIA G703) • Sources and Uses (showing budget in balance) • Conditional Lien Waivers (current draw) • Unconditional Lien Waivers (previous draw) • Payee Lists & Backup for Hard and Soft Costs • Construction Schedule (Updated)
What are the “typical” Construction Draw Package Requirements? (cont.) • Change Order Log (including Potential and Pending COs) • Title Update / Date Down Endorsement • Proof of Insurance on Stored Materials • Foundation Survey and/or Foundation Endorsement • Explanation for Contingency Usage • Explanation for Budget Reallocations • Construction Inspection Report • OTHER (i.e. Notice To Proceed, Permits)
What are some potential risks/defaults and how should these be addressed? • Construction Delays- • Once a delay is identified, ensure the construction interest line item is adjusted accordingly • Identify any risks associated with delays (ex. if there are any penalties for handing over the space to a tenant for TI build out) • Cost Overruns- • If contingency is not sufficient require borrower to deposit the shortfall in the budget immediately- do not wait for funds to run out. • Be careful of cost allocation reduction in line items to fund other line items that are over budget. • Communicate with borrower about future change orders and if lender approval is required
Potential risks/defaults and how should these be addressed? (cont.) • Liens-If liens are identified there are different options available • Check with disbursement agreement for guidance • Get communication from GC if lien was filed by a sub-contractor to understand the issue • Require the sub-contractor sign a conditional lien waiver before disbursing. • Short the draw funding by 150% of the lien amount • Hold off on funding until lien is cleared and provided proof of documentation (depending on lien amount)