With the hot commercial construction industry and growing economy, banks and other commercial lenders want to participate in the project development but are gun-shy after the painful lessons of the real estate market in the 1980s.
Fortunately, there's a new risk management alternative-funds administration-making it possible for commercial lenders to reduce their risk to almost zero.
No, it's not too good to be true. Through the process of funds administration of loans, everyone involved in the construction project - contractor, lender, property owner, developer, and subcontractors - is assured that the project will be completed on time, within budget, and that bills will be paid only as the work is completed.
The funds administration process essentially acts as an escrow service for large construction projects. The contractor and borrower give the funds administrator a detailed budget and timetable.
The lender puts the funds in escrow with the funds administrator; the contractor submits all invoices to the funds administrator; and the administrator distributes all payments to subcontractors and vendors.
Using the funds administration process, lenders can move beyond managing risk.
By allowing a funds administrator to manage the project, everyone involved in the construction process can focus on his or her specialty and get the job done.
Projects that benefit from funds administration include large construction projects such as apartment construction, commercial construction and renovation, transportation construction, as well as drilling and well plugging in the oil industry.
Funds administration also can be utilized with subcontractors such as electricians, plumbers, and air conditioning contractors. High-risk subcontractors that are difficult to replace on a construction site would also qualify. Additionally, hi-tech industries including software and hardware systems development and system upgrades are proving to be high- risk and excellent candidates for funds administration.
With funds administration, the risk of misappropriation is diminished, and all payments are made in a timely manner. Checks can be disbursed to a creditor in less than three days, and the funds administrator maintains overbillings for future project costs.
In short, the funds administration process ensures that monies intended to pay bills for specific portions of a project are used for that project and not diverted for other purposes.
In addition to managing escrow, funds administrators, who usually have a construction background, perform some essential project management functions.
For example, they could produce a report which tracks the projected budget and time line with monies spent on the project to date. Inspections could confirm whether the work is progressing at the expected pace and meets all necessary requirements.
This independent analysis is a key step in eliminating the miscommunication or misrepresentation that can derail a project quickly.
Both the lender and the borrower can rest easy because they obtain complete accounting for every dollar spent and are relieved of the day-to- day oversight of the project.
The process also facilitates timely dispute resolution. The funds administrator detects problems early, mediates if problems do occur, and provides significant insurance coverage on the volume of funds being handled to protect the lender.
Though the benefits of funds administration are obvious to the lender, the contractor also benefits.
The process enhances the contractor's credit by showing his commitment to proper management of project funds. In addition using a funds administrator can qualify contractors for deep discounts from vendors who are assured of prompt payment.
Third-party funds administration has become a proven way to boost contractors' and subcontractors' credit records as well as giving the bank, developer, and borrower a comfort level that is rarely found in the fast- paced commercial construction industry. Mr. Strauss is the president and founder of Funds Administration Services Inc. in Houston, Tex.