Managing risk in preparation for a church's loan approval takes savvy and careful planning.
Tim Lawrence · February 27, 2018
The typical time frame for required payments to contractors is 30 days, but that is not always the case, as this time frame is negotiated in the contract. If it is less than 30 days, this can create legal problems, unless the church has sufficient cash to float the payment to the contractor while waiting to get reimbursed.
Another issue is that the contractor, church, and lender may not always agree that the amount of work billed is commensurate with what is actually done. When the amount billed is significantly greater than the work actually done, this is known as overbilling.
Overbilling is so common in the industry that a certain amount of it is almost expected. There are a lot of reasons for it; most notable is that by billing ahead of the work, the contractor is trying to use the church’s or lender’s capital to replace their own capital outlay in the project, thus shifting risk from them to the church or lender.
Whatever the reason may be, the lender will typically have little tolerance for the overbilling, and will approve progress payments only within a small variance of what they think is appropriate. The church will then need to negotiate with the contractor for a smaller progress payment.
Since they have typically already signed the payment certification, this can be a problem. In order to resolve the situation, the church may have to make up the difference with its own cash.
Finally, the issue of retainage (sometimes called retention) can create progress payment issues as well.
Retainage is an amount that is held back from each progress payment to insure that all mechanics liens are released when the project is finished. Retainage typically runs between 5 percent and 10 percent. The more retention held, the more incentive a contractor has to get the liens released, and the greater cash requirement for the contractor, because they still have to pay the subcontractors in full.
Lenders also typically require some significant amount of retainage to be held from their disbursements throughout the project and some amount to be held until the lien period expires (the lien period is the time period where all parties involved in the construction of the project have the right to file a mechanics lien).
After lien period expiration, the lender then receives an endorsement indicating they have clear title, free of mechanics’ liens. This lien period can vary from state to state, but typically runs 60 to 90 days. Here is the rub: Most construction contracts require retainage be released to the contractor in 30 days, so there is a 30-day or more gap between when the lender releases the remaining loan funds to the church and the church is required to pay the contractor the retainage.
In addition, the lender’s requirement for retainage might be different than what is in the contract.
So throughout the project, the lender may be holding more money back than what is specified in the contract, causing the church to be required to add more of its own funds to the progress payments to the contractor. At the end of the lien period these amounts are reimbursed when the lender’s retainage is released, but the higher cash requirement is still there during construction.
What is the take-away from all of this?
Because of the nature of the construction progress payment process, the cash requirements of the construction project are likely to be higher than most churches anticipate. Because of this, lenders will look very carefully at a church’s cash position, and will likely require significantly more cash reserves on a construction loan than a traditional loan. The church will need to plan accordingly.
Bring in Your Lender Early in the Process. In summary, here are a few things a church can do to mitigate the risks from these danger zones and position themselves for financing:
Use traditional project delivery, with lump sum or guaranteed maximum price contracts, avoiding direct relationships with subcontractors
Have adequate contingency imbedded in the project costs
Protect the project with payment and performance bonds
Don’t begin construction until the loan is funded
Don’t plan on beginning a project until significant additional cash reserves have been set aside for progress payment and retainage issues
The five danger zones covered here are only some of the many pitfalls that await churches in their journey to constructing their [facilities].
The construction process is very fluid, and requires expertise throughout. Many churches realize this and seek wisdom from people experienced in commercial construction from the very start of the process. It is also important to navigate the financing requirements as early as possible, and to allow those experts on the financing side to collaborate with those on the construction side.
The reward is a smoother construction project, less risk, and a beautiful, completed building.