Originating or refinancing an incomplete construction project requires an additional set of tools and expertise to manage financial, legal, and market risks.

When you start a construction project from the beginning, you can meticulously plan details such as the target market, designs, budget, and phases, leading to fewer surprises. However, if you take over a midstream construction project—one that’s already underway – you may be faced with unexpected challenges and be forced to adjust, often increasing costs in both time and money.

When considering financing midstream or abandoned construction projects, assess your risks before committing capital. These risks, which span financial and legal uncertainties, market conditions, environmental concerns, and project management challenges, can all affect the project’s viability. Understanding them and conducting comprehensive due diligence is critical for making informed investment decisions and structuring financing in a way that minimizes potential losses. Traditional risk mitigation strategies are now enhanced by incorporating artificial intelligence (AI).

Let’s take a look at the potential risks of a midstream construction project.

Financial Risks

Midstream construction projects frequently face cost overruns due to uncertainties in completing the remaining work. Issues like previous mismanagement, unexpected delays, or inflationary pressures can drive up costs. Outdated or inaccurate original cost estimates make it difficult to forecast the financial resources needed for project completion. This uncertainty raises the risk of needing to inject more capital than initially planned, impacting the return on investment.

In addition, stalled projects typically experience cash flow disruptions when initial funding runs out. Cash flow for these projects often relies on reaching specific milestones, which may be delayed due to incomplete work or other challenges. Financing these projects involves considering the risk of not receiving timely payments or returns until the project resumes and becomes operational.

Financing delayed projects could tie up your capital longer than expected, potentially creating liquidity challenges if you need to reallocate resources. This risk is particularly significant for financial institutions that need to manage liquidity to pursue other investment opportunities or meet obligations.

Often, the original developer abandoned the project due to insolvency or financial distress. This means you may inherit the credit risk of the original borrower or need to evaluate the creditworthiness of new developers stepping in. The developer’s past financial struggles might indicate potential mismanagement risks or uncover unexpected hurdles that caused project disruption, leading to additional financial issues.

Legal and Regulatory Risks

Partially completed construction projects may encounter legal issues such as expired permits, zoning changes, or updated regulations. Securing new permits or amending existing ones can delay progress, increase legal costs, and heighten noncompliance risks. It’s essential to consider the potential need for additional regulatory approvals, which can be costly and time-consuming.

Stagnant projects often involve multiple contractors, suppliers, and stakeholders. When a project halts, disputes over unpaid invoices, incomplete work, or contract breaches may arise. Understanding the legal landscape is crucial, as you could be drawn into litigation or required to settle outstanding claims to resume construction, which would increase legal costs and delay timelines.

Establishing clear ownership of project assets can be complex, especially if multiple parties have claims against the property. Financing these projects carries the risk of inheriting legal disputes, which can be costly and time-consuming to resolve. Ambiguities in ownership can pose substantial legal risks.

Market and Economic Risks

Projects planned during times of economic growth may become less viable due to changing market conditions. Financing midstream or abandoned projects requires an analysis of current demand for the completed project. A downturn in real estate markets, shifting consumer preferences, or new industry trends can reduce expected returns, making the project less viable.

Likewise, inflation, interest rate increases, and changes in economic policy can raise construction, labor, and financing costs. Abandoned projects are particularly vulnerable to these challenges because delays expose them to changing economic conditions. For example, rising interest rates increase financing costs, straining the project’s financial feasibility.

Also consider that if new projects were completed while your project was stalled, increased competition may affect potential profitability. An oversupplied market or newer developments can make it more difficult to sell or lease the finished property.

Operational and Construction Risks

Accurately assessing the remaining work in a partially completed project is challenging and often requires careful due diligence. Unknowns like material deterioration or the subpar quality of completed work can lead to unexpected costs, potentially causing original investment projections to fall short.

Restarting a project often necessitates hiring new contractors, suppliers, and project managers. Integrating these new participants can be challenging due to differences in work culture, unfamiliarity with existing conditions, and the need to align project goals, potentially leading to delays and miscommunication.

Reestablishing relationships with suppliers and contractors disrupted during a project’s pause can be difficult. Additionally, changes in the global supply chain may affect your ability to source materials at the original costs, potentially impacting timelines and budgets.

Environmental and Social Risks

Previously abandoned projects may pose environmental risks, such as contamination or erosion. Restarting a project often requires compliance with updated environmental regulations, addressing any environmental damage, and ensuring standards are met. Failing to address these issues could result in fines or project stoppages.

Some midstream projects face community opposition, especially if they have become eyesores during the hiatus. Financing these projects may require managing community relations or dealing with protests that could delay or complicate construction.

Investors associated with projects perceived negatively by the public may face reputational risks. Community members might view the project as irresponsible or inconsiderate, leading to negative media coverage or opposition that could impact your standing in the market.

Risk Mitigation Strategies

To reduce risk on a midstream construction project, conduct comprehensive due diligence to understand project risks. This includes legal assessments, market evaluations, inspections, and financial analysis to identify potential issues early.

Artificial intelligence can help analyze proposed budgets by comparing them to historical data. Machine learning models can identify patterns, allowing you to avoid projects with unrealistic budgets.

AI also can assist in evaluating market conditions that affect a project’s feasibility. By analyzing market data, AI provides insights into regional economic growth, demand trends, and demographic changes. This information can help you assess whether the project will sell or rent quickly or if the market is oversaturated, impacting profitability.

AI tools, such as drones and computer vision, enable real-time monitoring of construction sites. This allows you to verify that work matches timelines and to identify delays or potential issues early.

Don’t hesitate to collaborate with developers who have a proven track record with troubled projects to reduce risks. Experienced partners bring expertise in regulatory navigation, construction optimization, and community engagement.

Importantly, use specialized insurance, like builder’s risk insurance, to protect against financial losses associated with delays or unforeseen issues, providing a financial safety net.

In conclusion, navigating the complexities of midstream construction projects demands a clear understanding of associated risks and the strategic application of risk mitigation techniques. Comprehensive due diligence, enhanced by the latest AI technologies, is essential for assessing financial, legal, and market conditions effectively. By embracing these advanced tools and strategic insights, investors and lenders can better manage potential pitfalls and capitalize on the opportunities presented by midstream construction investments.