Most lenders and many investors do not want to complete a distressed construction project without the insulation from liability afforded by a court-appointed receiver completing the project prior to sale. That is because the owner/builder is exposed to potentially significant long- term liability for construction defects, particularly on condominiums, apartments mapped for sale as condominiums, and tract housing projects where there are homeowners’ associations to prosecute claims long after the construction is complete.
However, stepping in from a cold start to secure, evaluate and complete a stalled, distressed construction project can be among the more challenging assignments a receiver can take on. That includes evaluating the construction in place, the underlying project approvals, and the probable cost and anticipated time to complete the project.
Typically, beyond simply completing the construction, the receiver is faced with the complex task of quickly and carefully identifying – and correcting – a myriad of construction issues that the architect, developer, contractor, subcontractors and suppliers were unable or unwilling to address, or, worse, that they may have intentionally caused or created as both time and money finally ran out.
A building or other construction project is not ‘complete’ until it has received a certificate of occupancy or similar approval from the public agency with primary jurisdiction over the project. Typically it is the city or county where the project is located, although it could also be a state, federal or even tribal agency. There may also be separate and significant tenant improvements or other project modifications necessary for the project to start generating income or otherwise be put into service for its intended use.
Unfortunately, time is the enemy on a stalled construction project: project permits and underlying approvals may expire, key design and construction team members may leave, completed construction may deteriorate from weather, theft and vandalism, and security and insurance costs can soar.
The good news is that with sufficient time and money, almost anything can be fixed. However, for distressed, stalled construction, the old saying, ‘it always takes longer and costs
more’ usually applies, for the cost to complete a stalled project is almost invariably higher than if the project was completed by the original developer without interruption.
Some Initial Priorities, Issues and Considerations
After being appointed, early priorities include walking the project job site to ensure that it is properly secured, and to get familiarized with the general condition and status of the project. Confirm that insurance policies are current, and that the receiver is named as an endorsed, additional insured on the policies. Determine what materials, if any, have been purchased and stored off-site or with suppliers.
Particularly if the borrower/developer and general contractor are still cooperative after the receiver is appointed, then the receiver should also make it a high priority to quickly compile as much information about the project as possible. Among other things, this includes contact information for everyone involved in the design, approval, construction, and inspection of the project, as well as the agency stamped, approved set of construction plans and specifications, the original inspection record card and the most current set of as-built drawings from the job site, as these are often updated from the original permit set.
‘Invasive’ inspections such as assessment of potential soil and groundwater contamination are often necessary and appropriate to fully evaluate the condition and status of construction. Those inspections may include mold, asbestos, structural, mechanical, electrical, low voltage, plumbing and roofing. However, invasive inspections – particularly environmental – can be problematic given the possibility that the results may have a negative impact on project value. If the court’s order appointing the receiver does not already address invasive inspections, the receiver may be well advised to consider obtaining an additional order from the court expressly authorizing those inspections.
Borrowers in distress often cut corners and make poor decisions. They will use cheaper materials, less skilled and/or less supervised contractors, and overlook mistakes and substandard construction – all in an effort to complete the project as quickly as possible with whatever funds are remaining.
Below is a list of some of the typical construction issues that can arise on a stalled project:
- Expired project approvals and construction permits
- Incomplete plans and/or permit applications for design/build work
- Design professionals, subcontractors or suppliers that are no longer in business or uncooperative and/or restrict access to permitted plans due to nonpayment
- Long-lead materials, fixtures and equipment not yet ordered, significantly delayed or unavailable
- Inadequate, improperly located, installed and/or delayed public utility installations
- Use of substandard, substituted or uncertified materials and fixtures
- Substandard or improper construction
- Incorrect clearances, setbacks, building height and other dimensional issues
- Construction extending past property lines, both above and below ground
- Low voltage access, communication, security and fire/life safety systems not designed, installed, inspected or operating properly
- Major building components damaged or compromised by prolonged exposure to weather such as wood framing, weather resistant barriers, insulation, drywall and flooring
- Compromised or voided warranties
- Theft of high value building materials and equipment stored on-site or installed such as copper electrical wiring, electrical switchgear, heating and air conditioning equipment and appliances
In addition, stalled projects often require 24/7 on-site security – and larger projects may need two or more security guards to properly secure the job site. Insurance policies may also need to be extended or converted to ‘vacant building’ policies. As a result, the receiver should be prepared for both security and insurance to be unexpectedly costly.
If the borrower/developer was ‘self-performing’ as the project architect and/or the general contractor – and to the extent that the borrower/developer has close relationships with the project’s subcontractors – it is likely that these ‘related’ project team members will, at a minimum, be reluctant to talk, and often will be uncooperative and adversarial.
The Construction Evaluation Process
Once the receiver has secured the job site and readily available project documentation, this is the time to engage appropriate third-party consultants who specialize in construction evaluation, unless this capability already exists within the receiver’s own staff.
First, compile and review the project’s approvals, the construction and consultant contracts, the building department inspection record card comments, other inspection reports (i.e. architect, structural engineer, accessibility, building envelope, acoustical, insurance carrier, deputy inspectors and loan disbursement inspector), the contractor’s pay applications and logs, and a current title report to identify mechanics liens and other documents of record. Look for issues that may have arisen during construction – and to what extent the architect, the general contractor, and their respective insurance carriers, may be contractually obligated to resolve those issues.
Talk with the architect, the other design and engineering consultants, the deputy inspector(s), the general contractor, subcontractors and major material suppliers. A great deal can typically be learned from the people actually working on the project. This includes whether they are interested in and/or capable of completing the project, the remaining issues, as well as who will need to be paid and how much they will need to be paid before restarting work. Ask about upcoming decisions, alternatives, and the cost and time to complete the project. Be aware, however, that the architect and other design professionals in particular may be reluctant to cooperate if they have unpaid invoices for their work on the project.
Initiate a series of project job walks. The initial review of project documents and reports will provide some indication of what to initially focus on. Each subsequent job walk will further inform the assessment of the status of the project. If possible, it is better to do separate job walks, first with the design and inspection teams, followed by the construction team. The design team often has a different perspective than the construction team. Project team members may be reluctant to be candid when both the design and construction team are together in the same room.
Once it is clear what is known and what is unknown about the project from the existing project team, it is time to separately talk with one or more third-party architects and general contractors who are ‘experts’ in this specific type of construction in the same city as the project is located. They may identify issues that the existing team may be reluctant to talk about or may not be aware of. Assume
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that the existing project team will find out about discussions with new consultants and contractors, since subcontractors all tend to travel in the same circles.
If the project has been stalled for some time, and many of the team members are gone, uncooperative or adversarial, it may be necessary to pay a third-party general contractor to prepare a cost-to-complete estimate and a completion schedule. Unless there’s a strong existing relationship with the contractor, they will often be reluctant to do this work without compensation.
It’s often best to delay talking with the city or any of the other public agencies involved with the oversight and approval of the project until later in the evaluation process. These conversations are certainly important, and often critical, but better to have after becoming fully informed as to the condition and status of the project – including the potential need to reinstate expired project and construction approvals and/or eliminate or modify burdensome conditions of approval, including costly required off-site construction requirements.
At this point it should be possible to develop a reasonably accurate ‘best-guess’ project completion budget and schedule, relative to the original project costs and status of completion, bearing in mind that material and labor costs have probably escalated from initial pricing. There may be significant additional costs and schedule delays to account for protective measures, corrective work, material lead times and soft costs incurred in evaluating and completing the project.
It is important to remember that regardless of how much due diligence is performed beforehand, with construction comes surprises – the ‘unknown unknowns’ that inevitably arise in any construction project. This is particularly the case in a distressed, incomplete project, where it is probable that the quality, fit and finish of the work has suffered as project funding has run out. Moreover, once things have become adversarial, existing team members no longer have the incentive to help identify and solve construction issues. The best ‘insurance’ against surprises is a thorough assessment, healthy contingencies for both budget and schedule, and a great deal of persistence and patience.
Project Completion Checklist
- Public Agency Project Approvals & Permits
- Building Permit Inspection Record Card
- Permit Set of Construction Drawings
- Civil Engineer
- Structural Engineer
- Mechanical, Electrical & Plumbing Consultants
- Waterproofing Consultant
- Acoustical Consultant
- ADA Access Consultant
- Utility Consultant
- Elevator Consultant
- Low Voltage Access, Security & Emergency Communications
- Other ConsultantsSpecial / Deputy Inspector Reports Deputy Inspector Reports
- Insurance – Property & Liability / Owner or Contractor Controlled
- General Contractor – 3rd Party or Self Performed
- Loan Draw Inspections
- Loan Draw Applications – Payment Status & Change Orders
- Stored Materials
- Status of equipment, finishes and fixtures not yet instlled
- Environmental Reports – Phase 1 & 2
- Asbestos & Mold Inspection
- Utility Status – Electricity, Water, Sewer, Gas, Storm Drains, Internet, Telephone
- Mechanics Liens
- Stop Notices
David Wald is President of Wald Realty Advisors. He has more than 35 years of commercial, multifamily, tract housing, and other specialty real estate and related operating business experience. He has been a receiver for over 25 years and has closed over 190 real property sales in receivership, including judicial foreclosure sales. Mr. Wald has significant experience with the completion, leasing & sale of distressed construction, and development projects in receivership.