Following these suggestions for project review and loan draws will help you define repeatable processes and reduce risk.

Construction lending can be highly profitable, and the demand for this type of financing continues to grow. However, profitability is closely tied to managing risk and proactively addressing potential failure points within a project.

To successfully manage construction projects to completion—on time, within budget, and without failure—you need the right processes and tools. These help to ensure repeated success despite changing market tides, and they will protect the interests of your business, customers, and investors.

Project or Feasibility Review

Before you close on the construction loan, a best practice is to complete a construction project review or feasibility review. This review will inform you of project readiness and determine whether the project meets your minimum risk profile. You will need to determine which factors are important to you. You may want to consider the following:

Budget line items. Review budget with line items in detail. For example, try comparing the proposed amount for a new roof to the average amount for new roofs in the area. This comparison will verify the right budget is allotted for each line item and you aren’t funding significantly under or over the actual scope of the project.

Plot plan with specs. A review of the plot plan with specs is an important part of a project review. You may find, among other things, that the planned setback does not comply with local zoning regulations or a utility pole is missing on the plan. Reconcile discrepancies to verify the plot plan is as accurate as possible.

Plan compared with the budget. With the line items and plans in hand, compare them to each other. Perhaps the plans include three bathrooms, but the budget only accounts for two. Not uncovering these kinds of discrepancies before the project starts could cost time and money to make things right later, jeopardizing the timely completion of the project.

You may also choose to review the flood certification, appraisal report, and surveys. They each provide information that’s important to a project.

Define your hard stops. Every private lender needs to set up their hard stops—triggers that indicate the loan cannot proceed until the need is satisfied. Suggestions for hard stops: non-executed documentation or the plans and specs not aligning with the provided budget and appraisal, if applicable. Any inconsistencies within the loan  documents should be addressed immediately.

Set expectations with the borrower. Before the project starts, review the plan with the borrower. Review the draw process, what is required to submit a draw request, when they can expect to receive funds, etc. If you are working with a borrower for the first time, make sure they are a good fit and will follow your policies and processes. Also, know the exit strategy. Is the borrower going to be able to exit at a profit?

The Right Tools for Managing Draw Disbursements

Just as important as creating pre-closing processes such as project reviews, developing the right tools to manage draw disbursements post-close and understanding your risk are critical to success. Efficiency is key to adhering to project timelines, and visibility at all levels will help you proactively manage risk if issues arise.

Spreadsheets are a very common tool lenders use to manage draw disbursements. Spreadsheets can be an adequate tool when loan volumes are low, but as your programs grow in capacity and complexity, the flaws inherent to spreadsheets will become readily apparent.

What are the drawbacks of using spreadsheets for draw management?

First, they introduce more risk. Manual data entry is tedious and can be heavily prone to errors.  Sharing real-time data is not possible, leaving borrowers and lenders operating with different sets of data. And, there is no built-in risk tracking.

Second, you can’t scale. Manual processes will limit your capacity to grow with demand. Most people can successfully manage only a finite number of loans on spreadsheets. As you see your construction portfolio grow, you will need to hire and train additional staff.

Third, visibility is limited. Reporting can be a difficult, manual process. And, you can’t control access based on roles or permissions.

Lenders with growing construction portfolios often use software designed to manage draw disbursements. Software intended for this purpose can improve process efficiencies and better manage risk and transparency.

No matter which tool you are using, make sure you evaluate your processes to ensure they can perform the following with ease:

Ensure the budget is always in balance. A basic of budgeting, tracking inflow and outflow is always important. Make sure you can view the real-time budget every time you look at the loan file. Be sure to check in on anything that doesn’t add up.

Track disbursement of funds compared to work completed. Before you release the draw funds, you will want to see the work that has been completed to warrant the draw request. Often, there is an imbalance in the funds compared to work completed. Sometimes it’s a mistake, and sometimes it’s on purpose (e.g., to obtain funds from one source to use on an alternate project).

View days between draws. Being able to observe how many days have passed since the last draw was submitted and received will bring your attention to possible problems or confirm everything is running smoothly. You have only a finite number of days on the loan, and draws should be taken at appropriate intervals.

View days until the loan completes. Understanding completion is, of course, important; however, you can also view this metric as a means to pipeline health. As one loan is completed, do you have one or two replacing it?

Track expirations of key documents and permits. The loan file is not complete without a list of permit expirations. If you use spreadsheets, you’ll need to set external reminders or work into your process a checking mechanism on key documents so the project doesn’t take on more risk.

View overall loan pipeline health. Just as knowing the “days until complete” on a singular loan can help you monitor your pipeline, take time to view the health of your entire loan pipeline. Each loan needs to be reportable, and you’ll want a method to aggregate all that information in one place so you can make the best decisions possible.

Although these are a few key processes for managing your construction loans, you may want to add additional tools for your particular situation. Use the suggestions that will work best to help you define repeatable processes and reduce risk.