Commercial Construction Tips – How to Avoid Going Over Budget

A commercial construction project can seem like a never-ending balancing act, like keeping a series of plates spinning. One plate represents keeping the project on schedule. Another spinning plate is ensuring that construction is completed properly and safely. And still another spinning plate is containing the project budget.

A commercial construction budget is influenced by a number of factors. Exceeding the budget can easily occur for reasons beyond the control of the owner, contractor, and project manager, including:

• A sharp increase in materials costs during construction.

• Weather fluctuations that slow or halt construction.

• Work stoppages.

• Frequent alterations to the design, materials.

Make a list

As one industry writer stated, estimating a project’s cost is the first step of construction cost containment. The project budget should list the essentials (non-negotiables) as well as the negotiables (the aspects of the project that can be reduced, modified, or eliminated in order to contain costs. Each line item should be carefully researched, sourced, and have a realistic cost applied to it. The budget should also include contingency funding.

Cost control challenges

Cost containment challenges are not always line item-related. There are a number of less-obvious but significant challenges to staying on budget, including:

• Poorly defined scope of project.

• Flawed estimating methodology

• Lack of project management policies and controls.

• Unrealistic scheduling.

• Insufficient planned-to-actual cost comparisons.

The big three

This trio of cost containment issues has been stated before and they are worth stating again. If The Big Three of budget issues are carefully managed, you can reduce or eliminate a number of budget overruns:

1. Incomplete design documentation: the architect’s rendering, plans, and specs that are turned over to the owner or project manager do not always include the in-depth details necessary for realistic budgeting.

a. Solution: the contract between the owner and architect should specify that all members of the architecture team will provide complete details, specs, documents, and drawings related to the project.

2. Pre-bidding document review: some contractors do only a general review of documentation before submitting their bids.

a. Solution: the language of the project owner’s contract should require all contractors who submit bids to acknowledge, in writing, that they have reviewed all specifications and plans. The bid price should cover all identified and “implied or express design intent” work.

Any materials or changes to design that the contractor feels are essential to successful completion of the project (but weren’t identified in the project/owner’s documentation) also should be included in the bid, along with explanations for the additional items.

This requirement should reduce or eliminate the need for contractors to seek additional compensation based on additional work necessitated by information “not shown on the original plans and specifications.”

3. The low-ball bid: underbidding can put the entire project at risk and cause it to far exceed the budget.

a. Solution: solicit bids only from trusted contractors who have successfully completed similar projects. They should have documentable records of completing projects on budget and on time.

Another cost containment option

Another cost containment option is to hire a skilled construction cost estimator. That person or team works with you to help you avoid out-of-control expenses, keep construction costs down, and ensure the project is completed within the agreed-upon timeframe.

It’s up to you

Ultimately, it is the owner and project team who are responsible for overseeing each phase, change order, and plan alteration to the construction project. There should be a well-defined process for change order submittal, review, and authorization. There also should be continual monitoring and updating of the budget so that you and your team know where the project financially stands all the way to completion.

Some Important Facts About First Position Commercial Mortgage Notes

Creating attractive interest is a challenge in today’s low interest rate environment. The attractiveness of First Position Mortgage Notes is in the fact that investors (lenders) are held in the first position as a lien holder of the property – so there is a hard asset (real estate) providing the security of their investment.

The 50-year average for homeownership in the United States is about 65%. Most experts see that number reducing as the move to rental communities continue to rise along with the challenges that younger consumers are finding in securing sustainable employment which is directly correlated to one’s ability (and desire) to own a home. The marketing for traditional residential mortgage financing in today’s marketplace has created a higher understanding of how these loans work for consumers. Couple that with the competition in the residential financing market and it is understandable why most adults understand residential financing. But what about Commercial Real Estate?

Each and everyday consumers leave their homes and visit multiple commercial properties – for work – for dining – for shopping – for entertainment – but few understand that differences in the commercial financing marketplace versus the residential financing marketplace. The term “commercial loans” is mainly segmented into “multi-family properties (5 plus units), office buildings, retail centers, industrial and warehouse space, single tenant box buildings (such as Lowes and Walmart), and specialty use properties such as gas stations, schools, churches, etc. Regardless of the use the access to commercial loans is quite different than residential borrowing.

In residential borrowing the normal procedure is for the lender to request 2 years of tax returns, bank statements, pay stubs, credit check, and appraisal of the property. The loan underwriters primary focus is the borrower’s ability (through an income and expense model) to make the monthly mortgage payments including taxes and insurance.

In a commercial loan the lender will first look at the condition of the property and its ability to service the loan out of the cash flow from its day to day operations. The lender will request copies of current leases (rent roll) and two years of the borrowers operating history. In addition, they will review recent capital improvements, internal and external photos of the property, and lien and title searches. With these documents in hand the underwriter will create a debt-to-service coverage ratio (DSCR) to determine if the property can cover the demands that the new loan will carry with it. In addition, the lender will look at third party appraisals paying attention to not only the property in question but also the surrounding area and the trends in the marketplace.

A commercial borrower needs to have strong financials and credit history to qualify for the loan. However, the lender places the greatest weight on the properties ability to sustain the loan over that of the borrower’s personal situation. This is in direct comparison to the underwriting of residential mortgages where the borrower’s personal financial situation is of a higher concern than the property that is part of the mortgage.

There are six sources for commercial real estate borrowing – Portfolio Lenders – Government Agency Lenders – CMBS Lenders – Insurance Companies – SBA Loans – Private Money/Hard Money Lenders.

Portfolio Lenders – these are mostly comprised of banks, credit unions, and corporations that participate in commercial loans and hold them on their books through the maturity date.

Government Agency Lenders – these are companies that are authorized to sell commercial loan products that are funded by governmental agencies such as Freddie Mac and Fannie Mae. These loans are pooled together (securitized) and sold to investors.

CMBS Lenders – these lenders issue loans called “CMBS Loans”. Once sold the mortgages are transferred to a trust which in turn issues a series of bonds with varying terms (length and rate) and payment priorities in the event of default.

Insurance Companies – many insurance companies have looked to the commercial mortgage marketplace to increase yield on their holdings. These companies are not subjected to the same regulatory lending guidelines that other lenders are and therefore have more flexibility to create loan packages outside the conventional lending norms.

SBA Loans – Borrowers that are looking to purchase a commercial property for their own use (owner-occupied) have the option of utilizing a SBA-504 loan which can be used for various types of purchases for one’s own business including real estate and equipment.

Private Money/Hard Money Loans – For those borrowers that cannot qualify for traditional financing due to credit history or challenges with the property in question – hard money loans may be a viable source of funds for their intended project. These loans have higher interest rates and cost of money than other types of loans. Regardless of the higher costs of borrowing – these loans fill a need in the commercial mortgage marketplace.

Commercial Mortgage Loans can be either recourse or non-recourse in their design. In a typical recourse loan the borrower(s) is personally responsible for the loan in the event that the loan is foreclosed and the proceeds are not sufficient to repay the loan balance in full. In non-recourse loans the property is the collateral and the borrower is not personally held responsible for the mortgage debt. In typical non-recourse loans a provision called “bad-boy clauses” are part of the loan documents which state that in the event of fraud, intentional misrepresentation, gross negligence, criminal acts, misappropriation of property income, and insurance windfalls, the lender can hold the borrower(s) personally responsible for the debt of the mortgage.

Understandably, in commercial mortgage negotiations the lenders prefer recourse loans where the borrowers would prefer non-recourse loans. In the process of underwriting the lender and borrower(s) work to create a loan that meets both parties need and objectives and if an impasse presents itself – the loan is not issued.

The world of commercial mortgages offers investors the ability to participate in a marketplace that can have attractive yields, principal safety through lien positions on real estate assets, and durations (12 months to 5 years) that are acceptable to most. The creation of ongoing monthly interest through holdings such as Commercial Mortgage Notes is attractive to both consumers and institutional investors.

Commercial Property – What to Do If the Lease Is Unsigned

In commercial property management and leasing you frequently come across the problem of the tenant delaying the signing of the lease. It can be for a number of reasons such as:

  • The complete terms of the lease are still being negotiated
  • The tenant is still finalizing their fitout design
  • The various partnership members are not all available for signature
  • The documentation is still with the tenants solicitor
  • The business or government department is taking time to process the document
  • The decision makers are away
  • Approvals for permitted use are delayed at local council

So the list goes on and you will see many variations of the problem. Tenants will give you so many different reasons why the lease is still outstanding. Frequently the delay process is not as it seems and there are other alternatives that the tenant is adopting for their own reasons. Tenants will not tell you the whole truth; that is a fact.

The signature on a lease is then a critical element of making the tenancy available for occupancy. In almost all lease situations, you would want the tenant to satisfy the following criteria before the keys to the tenancy are handed over:

  1. The lease is totally and correctly signed
  2. The plans and drawings associated with the tenants fitout have been submitted to the landlord and are approved
  3. The plans and drawings associated with the tenants fitout have been submitted to the building control board or local council and are approved
  4. The first months rental is paid in advance in accordance with the lease documentation
  5. The appropriate personal or bank guarantees are provided to the landlord in accordance with the agreement to lease
  6. All associated documentation and disclosures tied to the lease implementation are correctly served and satisfied
  7. The deposit required under the lease agreement or lease arrangement is paid

The golden rule in the leasing a property to a tenant is that all lease requirements are satisfied in accordance with the property managers instructions and the landlord’s requirements before any keys and tenancy access are given.

It should also be said that any incentive to be made available to the tenant as part of the new lease structure should not be released or made available until all the six points above are satisfied.

In most instances with commercial property, the tenants you work with are very experienced in business and negotiation. They are likely to be more experienced than the property manager or the landlord. The tenants will set up the leasing situation to their own advantage during the lease negotiation.

So the clear message here is that the premises should not be handed over to the tenant until all lease documentation requirements have been satisfied correctly and legally.