Construction materials

5 Steps to Take When Building Materials Are Delayed

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Many commercial buildings currently under construction contain materials from Chinese manufacturers and other global manufacturers. We should consider the amount of building materials that will now be delayed or reordered due to the coronavirus. And at what cost? What is the impact of these delays and cost changes on the sustainability of the original construction budget?

The key to all of this is to have an open, frank, and timely conversation between development developers, lenders, and the construction management team. Here are five talking points that counterparties should cover as the impacts of the project continue to evolve from day to day.

Sources of alternative materials

When it comes to avoiding increased costs, it is crucial to quickly consider researching alternative material suppliers who are reliable alternatives. In many cases, these can be from national sources. The rapid search for alternatives will allow the project to continue moving forward during the term of the contract and the available contractual extension periods.

Contingency use

If alternative materials are required and purchased, and in the event that cost increases occur, contingency balances will be impacted. The contingencies of general contractors and lenders must be carefully managed in the short term. Budget reallocations will also come into play, as the construction management team looks for ways to manage spending in increasingly difficult market conditions.

Cost increases that drain contingency balances will put further financial pressure on sponsors and lenders. Capital injections to cover cost overruns and “reloadable” emergency balances may be required from sponsors. Lenders will likely tighten controls on contingencies and reallocations to ensure budgets remain fully capitalized, putting additional pressure on the construction loan.

Milestone failures, delays and extensions

As soon as a sponsor suspects supply chain issues, it’s imperative to redefine the time it takes to complete. Bring this new project schedule to the attention of the lender immediately and discuss the extension and modifications, if necessary. Good news travels fast… bad news travels faster. Milestones and other covenants in the construction loan agreement that are not met will be closely monitored during this period. Non-monetary defaults and related waivers, if any, will be negotiated on a case-by-case basis. Clear and open dialogue with leaders and portfolio managers can create a positive and collaborative environment.

Determine the adequacy of the interest reserve

Construction loans have an interest reserve balance that pays monthly interest charges, so one needs to determine how well the current interest reserve balance will carry the loan. Similar to cost increases, a capital call may be required to “top up” interest reserve balances if the revised project schedule completely depletes these reserves before completion. In view of the declaration of national emergency, lenders may be able to defer interest or make other accommodations during this time of hardship. Again, communication between parties can help all parties plan and meet their internal governance and control requirements.

Be aware of the effects of the market

Regardless of the source of repayment (rental or sale), commercial project developers must be proactive and deal with emerging disruptions with a sober consideration of downside risks. All measures must be taken to protect the business plan of the project. Contracts supporting the primary source of repayment should be carefully monitored to preserve trade exit strategies. This means that sales contracts, pre-lease agreements and other forms of future cash flow dependent on the completion of the project and the delivery of the physical space should be reviewed, confirmed and extended as necessary. . Negotiations to recast term commitments may be necessary to preserve loan performance.

Pandemic force majeure will become a topic of frequent debate. Confusion between sponsors, general contractors and lenders will arise if losses start to pile up. These will be tough times and share some similarities with 2007-2009, where the projects were likely to face a series of adversities. Strong, stable leadership that aggressively makes critical path decisions has the best chance for success.

Jim Fraser is the Director of CRE Strategy at Built Technologies.

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