Construction Monitors: How Borrowers, Lenders, Developers, and Investors Can Better Partner
The Developer and Equity Partners Perspective
by John H. zumBrunnen, CEO, zumBrunnen, Inc.
In my previous “Construction Monitors” article, I promised to discuss the perspective of the developer (owner/borrower) and equity partners for hiring an independent third-party construction consultant to monitor their development projects. Most often, this third-party consultant can also be approved by the construction lender to fulfill the lender’s requirement for their own bank inspector. As noted in my previous article, when an independent third-party is hired as a construction monitor, and also reports to the lenders, the entire project team (borrowers, developers, architects, contractors, financial team, and board members as may be applicable) shares in the reporting and subsequent benefits. The consultant’s construction monitoring service typically includes providing a project pre-closing due diligence report (pre-closing report) and conducting monthly site inspections and issuing monthly reports, which include contractor payment approvals.
The consultant attends the monthly Owner/Architect/Contractor (OAC) meeting, which includes the entire project team: developer (owner), contractor, and architect. The meeting agenda consists of a detailed site inspection, contractor payment approvals, and a review of project status including schedules, budgets, change orders, and project issues. The consultant’s site inspection reports are shared with the entire project and financial team. The reports are real-time objective reports summarizing the OAC meeting and a monthly reconciliation of the total hard cost budget to determine sufficiency of funds to complete the project.
For the successful developer, the rationale for utilizing third-party independent construction consultants is a bottom-line decision. Their goal is to successfully develop and deliver a quality project within budget and on schedule, while maintaining “excellent” relationships with all parties. The best projects are those where all parties meet their goals (profit margins, etc.). Developers realize by meeting the expectations of all parties, they are building the team for the next successful project! A successful development team recognizes the full value that an independent consultant brings to the table. Not only do they gain the perspective of a neutral and experienced construction expert and facilitator, but also, they realize the value that transparency of sharing in real-time, the project status (as to quality, progress, and budget), provides to the project and financial team including equity partners and lenders.
Problems and obstacles will be encountered on every project; it is not a matter of if, but when and how these issues are addressed, that is critical. The very best way to resolve problems is in early detection and disclosure. The earlier a problem is identified and brought to the team’s attention, the more options there are for a satisfactory solution. This strategy of early detection and transparency creates and ensures an atmosphere of trust and team building, which ultimately helps underwrite a successful project.
An experienced independent consultant first and foremost realizes he is a facilitator, not a director. He is looking to see that each party is performing in accordance with their contractual obligations. For example, is the contractor properly coordinating subcontractors and ensuring quality and compliance, such as is the roofer coordinating his work with other work, protecting materials from the weather, and properly installing the roof? If the consultant discovers deficiencies or shortcomings in a process such as this, it is his role to ensure it has the team’s attention, and guide the team in determining how and when the issues will be resolved. If the issue is design related, the consultant will coordinate with the design team to come to a resolution. The construction administration process of handling changes, both design related and non-design related, is a critical process that must be done professionally and correctly to ensure the budget and schedule are maintained. The consultant has no real direct authority other than ultimately, he must approve all hard cost payments. His real power comes from the respect and trust he earns based on his experience and his objectivity and neutrality!
These same concepts apply to hard-cost payment approvals and budget reconciliation. The consultant approves the payments, but first must be assured there are sufficient funds in the budget to make the payments. To reconcile the budget, he must have open and timely discussions with the entire project team as to pending and potential change orders, including time delays, which can have direct cost impact to the budget and/or the ultimate financial success of the project. The financial success is bottom line to the developer and his investors! Here again is where real-time reporting and transparency in budget and schedule reviews can prove critical to all.
The construction consultant also has a key role in the pre-construction and pre-financing process. It is best to bring the consultant on board prior to final pricing and execution of the construction contract and the final permitting of the design documents. This allows the consultant to review and comment on the construction contract terms and budgets to ensure lender requirements are met and budgets are all inclusive.
Timing of the execution of the construction contract to establish a firm price can prove critical. The best time is when the design and permitting process is complete. However, in many cases, this is not practical, as lenders will want an executed contract prior to financial closing, which usually occurs prior to the final pricing of changes driven by the permitting process. The longer the developer can hold off while finalizing permitted design document on which to establish a firm GMP (or Lump Sum) contract, the better chance of succeeding budget wise. Note that a contract can be executed at any stage of design, but the earlier it is executed in the design process, the more one must carry as contingency in the contractor’s and the project budget. Contingencies must be adequate to handle the changes that come later due to the evolution of the drawings and project, not only from a developer’s perspective in scope changes, but also from the required revisions that will happen as part of the permit reviews process. Making objective judgements of the adequacy of the overall budget, including budget contingencies, is a critical part of the consultant’s pre-construction services and reporting.
The financial parties, such as equity partners and lenders, etc., want, need, and appreciate the transparency an objective third-party brings to the table. This process ensures that everybody receives the same accurate and timely information so they can remain focused on the task at hand and contribute to the success of the project.
For those projects that are developed by commercial real estate developers, the developers want to sell their projects as soon as possible, preferably before they even start construction. The future owners will want assurance the project is built to their standards. For projects sold any time prior to completion of construction, the future owners can also be a party to the construction consultant’s monthly reports. This helps assure a ready transfer of ownership once the project is completed. If future owners are not a party to the reports, most will hire their own inspector prior to taking ownership. When these inspectors find issues with construction quality and compliance, the issues will need to be resolved prior to completion of the sale. This can delay the sale and can prove very expensive to the developer. Here again, the progressive and successful developer realizes that his transparency with the future owner during construction will set the stage upon project completion for a seamless transfer of ownership!
In our next article, we will discuss the lender, contractor, and architect perspectives pertaining to the involvement of independent third-party construction consultants and the return on investment.
John zumBrunnen is Founder and CEO of zumBrunnen, Inc., an independent construction and building consulting firm founded in 1989. zumBrunnen has a BS in mechanical engineering from the University of North Dakota, completed the US Army Corps of Engineers Training Program in 1972, and is a member of LeadingAge and Community Associations Institute on national and state levels. zumBrunnen has 40+ years of experience in construction, property assessment, development, and reserve budgeting. He is the inventor of the FacilityForecast® software system and a respected author and speaker in the industry.