Construction Lending: Key Issues for Negotiation and Documentation - - PowerPoint PPT Presentation

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Presenting a live 90-minute webinar with interactive Q&A

Construction Lending: Key Issues for Negotiation and Documentation

Mastering Conditions to Advances, Loan Balancing, Payment and Completion Guaranties, Retainage, and HVCRE Equity Requirements

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, APRIL 27, 2017

Lauren E. Anderson, Hillis Clark Martin & Peterson, Seattle Lisa Berden, Member, Dorn Berden, Southfield, Mich. Heather M. Dorn, Member, Dorn Berden, Troy, Mich.

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During this presentation, we will define:

• the construction loan process
• the risks involved with

construction lending; and

• the steps that lenders and their

legal counsel can take to minimize these risks by conducting sound due diligence and drafting solid loan documents. We will also focus on key provisions and documents that every lender’s counsel should have in his or her arsenal, and advise you of the HCVRE Equity Requirements that affect construction loans.

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• I. Introduction

Construction lending fills the short-term credit needs of developers. These loans focus upon the development of:

• office
• retail
• industrial
• hospitality
• residential

They generally take place after the inception of a business plan/feasibility study and during the development phase of the project.

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• I. Introduction

The Key Aspects of Construction Loans:

• Loan Term
• Disbursement terms and draw requests
• Repayment terms
• Collateral/Guarantees
• Representations and Warranties
• Default and Remedies
• Take-out strategies

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• II. Parties to a Construction Loan

Lender(s):

• Banks
• Individuals
• Credit Unions
• Collective Funds
• HUD
• Mezzanine Lenders
• -Consider an Intercreditor Agreement, which establishes the terms of

repayment between senior and junior creditors.

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• II. Parties to a Construction Loan

Borrower: land owner or developer Guarantor(s): individual(s) with established creditworthiness, who guarantee(s) the repayment of the loan. Examples of Guarantors: 1. Where LLC is the Borrower, Members are guarantors 2. Where C corporation is Borrower, Parent is guarantor 3. Where there is a ground lease scenario—Landowner can be guarantor

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• III. Construction Lending Risks

The biggest risk to construction lenders is the repayment of their loans.

• Initial due diligence review is a very important step to lenders.
• Careful contract drafting is also essential.
• -Checklist of essential documents (attachment)

Repayment is dependent upon the project’s successful completion, which in and of itself is subject to many risks.

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• III. Construction Lending Risks

Risks to Successful Completion and therefore loan repayment:

• 1. Fraudulent diversion of the construction draws:
• Consider whether there are multiple contemporaneous projects.
• Lenders can minimize this risk by carefully drafting draw request

provisions.

• Obtain Loan Policy of Title Insurance and seek materialmen

endorsements.

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• III. Construction Lending Risks

Risks to Successful Completion and therefore loan repayment:

• 2. Liens filed by contractors, subcontractors, or materialmen for lack
• f payment.
• Lenders must consider the construction lien statutes in their

jurisdiction and understand the priority of construction liens with respect to their mortgage interest.

• Record security interests in a timely fashion.
• -Mortgage
• -Assignment of Leases and Rents
• -UCC Financing Statements for Personal Property

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• III. Construction Lending Risks

Risks to Successful Completion and therefore loan repayment:

• 3. Failure of contractors or subcontractors to complete the

construction due to inadequate experience, negligence, or financial failure.

• Review Development Agreement
• Review Contractor/Subcontractor Agreement
• Review Architect contract

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• III. Construction Lending Risks

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Risks to Successful Completion and therefore loan repayment:

• 4. Cost overruns due to unforeseen conditions:
• low-ball bids
• change orders
• cost increases (labor/materials)
• labor shortages/strikes
• soil conditions/weather
• force majeure (earthquakes, tornados, storms)

• IV. Due Diligence

In order to obtain the knowledge and understanding needed in any construction deal, Lenders engage in extensive due diligence.

• A. Borrower and Guarantor. Lender must obtain sufficient information to ensure

that Borrower and Guarantor:

• 1. Have authority to borrower money or guaranty a loan, as applicable,

and enter into their respective loan documents

• 2. Are in a financial position to support debt service and guaranty
• 3. Meet all federal regulatory requirements

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• IV. Due Diligence
• B. Property. At the end of the day, whatever the stage of construction, this is

the Lender’s collateral. Lender needs to review all documents relating to the condition and the value of the Property.

• 1. 2006 ALTA Title Policy and Endorsements
• 2. Survey (preliminary and final)
• 3. Environmental Reports and Reliance Letters
• 4. MAI Appraisal (“as-is”, “as-completed” and “as stabilized”)
• 5. Pre-Leasing and Pre-Sales
• a. Pre-Leasing and Leases
• b. Sale Contracts/Minimum Sales and Release Price Schedule

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• IV. Due Diligence
• C. Construction of Project. In order to ensure construction of the Project in a

good, workmanlike manner that will support future loan advances, Lender should review:

• 1. Construction Budget
• 2. Plans and Specifications
• 3. Construction Schedule
• 4. Contracts (Contractor, Architect, Engineer)
• 5. Permits
• 6. Availability of utility service
• 7. Additional insurance

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• IV. Due Diligence
• D. Stabilization of Project. The Project obtains its real value once construction is

complete and can be sold or leased, depending on the nature of the Project.

• 1. Collateral value based on
• a. Current/projected vacancy and absorption values
• b. Lease renewal trends and projected rents

c. Time frame for obtaining stabilized occupancy

• d. Net Operating Income of the property
• e. Any cross-collateralization
• 2. Loan Take-Out Options
• a. Conversion to permanent loan
• b. Find a buyer

c. Refinance

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High Volatility CRE Regulations

Exemption from HVCRE designation, borrowers who originate commercial acquisition, development and construction:  loans must meet a 15% equity requirement,  Borrow $$ must be first in; and  leverage on loan cannot exceed 80% LTV .  OR, a Community Development Project

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High Volatility CRE Regulations HVCRE

If exemption conditions not met:

Loan subject to a 150% risk weight requirement -- up from prior 100% requirement. Loan stays designated HVCRE until converted to permanent financing, sold or paid in full. Funds must come from Borrrower, not a grant or other project loan Soft costs contributed by Borrower can be included in Borrower contribution SBA loans not automatically exempt Any contribution to the project must stay in the project for life of project

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Project Guaranties & Other Credit Enhancements

Payment Guaranty: Guarantor agrees to pay costs to complete project and other costs included as guaranteed obligations (ie, enforcement costs). Completion Guaranty: creditworthy principal or affiliate of the borrower guarantees completion of construction. Courts unlikely to require specific performance. P&P Bonds: insurance contract insuring bonded contractor will (1) complete the construction project and (2) pay its subcontractors. Lender named by surety as a "co-obligee" pursuant to a dual-obligee rider attached to the P&P Bond. Difficult to obtain & increase project costs, may end up litigating to get coverage.

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Project Guaranties & Other Credit Enhancements

LOC: irrevocable, standby LOC - unconditional obligation of an issuing bank to, for a specified period of time, pay the Letter of Credit beneficiary (i.e., the construction lender) all or some portion of the face amount of the Letter of Credit upon demand and presentment of the Letter of Credit to the issuer. Event of default or failure to renew LOC as conditions to draw on LOC (in loan agreement). LOCs even more expensive that bonds, but provide readily available cash. Environmental Indemnity: A credit-worthy entity backs borrower’s obligation to keep property free and clear of hazardous materials, including cost of remediation and compliance with environmental law & regulations.

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Advances: CONDITIONS

 DRAW REQUEST REQUIREMENTS Contractor submit a draw request for review and approval. Draw request lender form or AIA G-702 (Contractors Application for Payment) and G-703 forms (Continuation).

• has work been completed
• what has been done (is loan in balance)
• project is lien free
• percentage of project complete
• confirmation that the work completed meets the contract

specifications.

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PROJECT MODIFICATIONS

 Change orders

• GC may bid low (limit scope), win contract, then issue change
• rder(s)when project requires work outside the scope.
• Inefficiencies in design-build projects;
• material cost increases or change in materials;
• Inaccurate cost estimates;
• Developer/end user-requested changes.

usually = increased costs/risk of going over budget Sometimes reduce costs (value engineering) with changes to the building. Lender wants approval over change orders; borrower doesn’t want delays due to seeking lender approval

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LOAN BALANCING

“ loan in balance” = unfunded loan is sufficient to complete the project Budget busting factors: change orders, reallocation to budget allocations, contingency allocations IF remaining funds insufficient based on budget, Lender has right to declare loan out of balance. Remedies: institute default-rate interest, stop funding, shut down the project.

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PRE-LEASING & PRE-SALES

Is building speculative? Requirements for set pre-lease/sales prior to loan disbursement (25-50%)

• Lessens credit risk where at least partially pre-leased or pre-sold
• Meaningful deposits collected (are these real commitments)

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STORED MATERIALS

 Borrower may request advance to fund or pay for materials.  Loan should disclaim any obligation for making such advances as lender is paying for materials for which it has no perfected lien.  If lender exercises any remedies, remedies would not extend to off- site materials, even if paid for with the loan proceeds.

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RETAINAGE

 Typical retainage of each advance: 10% of either:

― The contract price of the work; or ― The value of work.

 Releases subcontractor-by-subcontractor basis:

― Full completion of all work to be performed by such subcontractor; ― 30 days after date subcontractor last provided work or materials to the project; and ― Full and final lien waiver and release.

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Thank You

Lauren Anderson Hillis Clark Martin & Peterson lauren.anderson@hcmp.com Lisa Berden Dorn Berden lisa@dornberden.com Heather Dorn Dorn Berden heather@dornberden.com

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