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Financing and Restarting Stalled Projects
From coast to coast the American landscape is littered with thousands of stalled, partially built, financially distressed or bank owned properties. New York City alone has stopped construction on at least 30 project sites with the Building Trades Employers Association (BTEA) reporting nearly $5 billion in delayed projects.
American Institute of Architects (AIA) has established a database to identify developers with new investors and architects for stalled projects AIA Stalled Projects. In January 2012 after two and half months, 36 projects have been identified worth a total of $1.2 billion. AIA’s economic research group has found that the share of stalled projects due to financing challenges has doubled since 2008 with one-in-five projects having difficulty obtaining financing.
Stalled and abandoned projects have unique challenges and risks. A specific strategy must be developed outlining knowledge and management of those exposures. This strategy will assist in successfully restarting and completing a stalled project and aid in obtaining project financing.
Project Opportunities with Financing Limitations
Multifamily projects and specifically apartment projects along with the local retail is on the recovery across the U.S. However, many projects are being limited by financing and credit constraints reported by the National Association of Home Builders (NAHB). NAHB reports that multifamily housing demand will outpace financing capacity putting the brakes on recovery efforts. NAHB is forecasting construction of 208,000 multifamily residences in 2012, however that figure is well below the 350,000 units needed to maintain balance in the market. NAHB’s states credit restrictions impacting recovery with capital and developers not able to obtain the financing needed.
Stalled Projects Weight on Banks
To understand the financing challenges, we have to look at the impact construction loans has had on the banking industry. In 2011, about 20% of the $440 billion construction loans were more than 30 days past due, according to Foresight Analytics. In 2010, FDIC reported that for all loans, the average default was 5.5%, real estate loan defaults were at 7.6%. However, the default on construction loans was the highest for all loans types at 16.8%. In 2010, a Congressional Oversight Panel stated, “Construction loans have the biggest losses over any other loans”.
Failed Banks
Banks fail when they lent money to customers who did not or cannot pay them back. In the last three years, 396 banks have failed in the United States. In 2009, 140 banks failed, 157 in 2010 and in 2011 it was 92. The number is coming down, however most of the failed banks are made of the smaller community banks, that provide a good percentage of construction loans.
Important Point: The majority of banks that have failed had a larger percentage of construction loans.
The residential real estate loan category continues get the headlines in the financial bank collapse, however these were the secondary sources of distress for lending institutions with $136 million in underperforming loans, or 22 % of the total defaulting balance. The leader was Commercial real estate loans that comprised of $401 million, or 65.1% of the total $617 million in underperforming loans at the failed banks. Construction and land loans made up $254 million while commercial mortgages comprised $147 million of the total underperforming pool.
Stalled projects are among the biggest risk and liability exposures for banks that have been forced to take over ownership for these half-baked projects. Sites that are not properly maintained, become safety hazards and risks to the community and residents. These projects have even have become havens for criminal activity, adding risk for banks. Legislation has been put into place in parts of the country requiring the site be maintained and security provided while construction is halted, adding additional costs for the banks.
Project Specific Risk Management Plan
It only makes good business sense that under the right circumstances, banks would welcome the opportunity of unloading the financial and risky burdens that come with having stalled and abandoned projects on their balance sheets. However, based on the high percentage of defaults of construction loans, it has to be a good risk for the banks.
Construction loans are story loans, and Project Owner/Developers with the help of the design, construction and risk management professionals must develop a clear risk management strategy for successfully restarting and completing these project. This can be accomplished through a
"Project Risk Assessment & Risk Management Plan".
Project Risk Assessments been used on higher risk projects such as condominiums to evaluate risks, helping to improve overall project performance and to obtain a "Project Specific PL Insurance Policy" for the design team. On a firm specific basis, risk assessments have been used for design firms that have had claim trouble, and are having difficulty purchasing Professional Liability (PL) insurance at reasonable terms and rates.
Having a "Project Risk Assessment & Risk Management Plan" would enhance the financial underwriting for banks in the areas of project delays, cost overruns, change orders, litigation and others. Categories that have the ability to impact project cost and having a loan paid off on time. A Vice President, Construction Loan Officer, of Special Assets at a national bank stated "project loans that have a "Project Risk Assessment & Risk Management Plan" would be viewed favorably over other loans".
Project Condition
The unique challenges and risk for partially constructed projects is that many have been left dormant, open and exposed to the natural elements causing damage to materials, systems and products. Stalled projects and structures need to be assessed by design and construction professionals determining the condition of the property, completed work, what needs to be completed, and what work needs to be repaired or torn out completely.
Original design plans need to be reviewed for compliance along plans developed based on changes for the new project's size and use. Risk management, attorneys and insurance professionals specializing in construction and transactional acquisitions should be engaged to assist with the due diligence needed through the negotiation process to identify the warranties and liabilities to help avoid lawsuits down the road.
Insurance Concerns
There are insurance issues that need to be addressed identifying who is legally responsible for the original construction, deficiencies, noncompliance, and code violations if any. This is extremely important and should be addressed early on and resolved during the negotiation process of the project. Identifying if the original parties are responsible or will such liabilities can be transferred to the new Owner/Developer and project team members is required. Determining the status of what insurance is in place, and what is needed is very important.
Conclusion
There are thousands of stalled and abandoned projects across the country. Implementing a risk management plan for managing risk and concerns for all parties for successfully restarting, financing and completing these projects is essential.
There is a great deal of up front due diligence needed in assessing the status and condition of stalled projects. That is going to take time, money and expertise that is extremely important when considering and restarting these projects. New Owners, Architects, Consultants and Contractors are well-advised to seek expert advice when considering a financially distressed and stalled project. This could be the difference in whether a project ultimately results in a profit or a loss.
If you have any questions or comments, or would like more information, please feel free to contact SmartRisk. mailto:tcorbett@smartrisk.biz
You are welcome to forward this newsletter to others who may be interested.
Thank you.
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