Independent Banker - June 2023 - 47

efficiencies in processes, as well as
tools that can help banks optimize
profitability. " It's important for
banks to understand the structure
of a [consumer] construction loan
as it relates to profitability so that
they have a good idea of their return
on investment in that asset, " says
Shannon Faries, director of risk
management at Land Gorilla, a
construction loan management
software provider.
* Who is the qualifying partner for
the general contractor's license?
* Does the builder have adequate
general liability insurance as
well as worker's comp coverage
for its employees?
The company developed a Weighted
Average Yield (WAY) calculator
to assist with that assessment. It
captures information such as the
lender's cost of funds, the borrowing
rate during construction, origination
income, amortizing interest at
completion and gain on sale.
" A [consumer] construction loan
is an asset, and the picture that we
like to paint for our clients is to really
understand the value of the asset, "
says Faries. That assessment also
helps to determine if a loan is priced
appropriately relative to the risk.
Getting projects to
the finish line
The biggest risk for a consumer
construction loan is failure to
complete. " If you don't get the house
built, what you get back is a nonsaleable
asset, " Faries says. " That is a
big problem. "
The number one reason for failure
to complete is the builder or the
general contractor. Due to liability
reasons, it's never the lender's role
to approve a borrower's choice of
a builder or contractor, cautions
Faries. However, it is important
to conduct due diligence on a
builder's background and experience
to either accept or decline the
borrower's selection.
Some examples of questions a
lender should ask the builder as part
of that due diligence include:
* What is the structure of the
business?
* Who is the primary owner of the
general contracting company?
-24.2%
DECLINE IN SINGLE-FAMILY
HOME STARTS IN 2023
-23.8%
DECLINE IN MULTIFAMILY
STARTS IN 2023
A second reason a project can fail
is that the budget isn't sufficient to
cover the costs. It is important for the
lender to conduct a project feasibility
analysis, which in some cases is a
simple review of the construction
contract and project budget to make
sure it makes sense and all of the
numbers add up.
" You would be shocked to see how
often our [risk analysis] group reviews
the budget and discovers in the
analysis that they're missing things
like doors and windows, " Faries says.
The analysts at Land Gorilla make a
point to count the number of windows
in the building plan to make sure
that the line item in the budget for
windows is reasonable based on the
building plan.
+13.7%
INCREASE IN SPENDING
ON NONRESIDENTIAL
CONSTRUCTION IN 2023
Sources: Fannie Mae Housing Forecast Feb. 2023, AIA
Consensus Construction Forecast, Jan. 2023
The recent period of runaway
inflation and soaring construction
costs highlighted the importance of
having a good contingency reserve
to make sure a project has adequate
financing. " Every construction-toperm
loan should include a line item
for a contingency reserve account
that is owned by the borrower, "
says Faries. That helps to protect
the borrower and the lender from
unknowns that occur during the
construction period that could affect
the cost.
Avidia Bank in Hudson, Mass.,
offers a construction-to-perm loan
product with financing that is based on
the to-be-completed value of the home.
The biggest risk is that construction is
either not completed or it's not built
according to the original plan.
" Those risks are mitigated by our
underwriting process, " notes Don
Frost, CFP, executive vice president,
consumer banking at $2.5 billionasset
Avidia Bank. As part of that
process, its lenders make sure that
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