Fraud is a concern in almost any industry, but the area of construction seems to be particularly susceptible to this malady. As a fairly recent study has shown, the amount... Read More
The Basics of Stored Materials in Construction
Construction projects and loans obtained to finance them contain a number of articles that may seem trivial at first but can lead to serious complications and problems if not given proper care and planning. Stored materials are a perfect example, both from the lender and borrower perspective as well as when dealing with contractors.
Stored materials are materials and items purchased ahead of their planned use in a construction project. Purchasing all construction materials on a day-to-day basis would be logistically impossible in most cases and exceedingly expensive. This is why many materials are commonly bought in advance and stored for later use. It all seems simple enough, but can lead to difficulties in loan negotiations and further down the road in dealing with the general contractor. Let’s take a closer look.
What’s the Big Deal with Stored Materials?
Construction materials generally take up two thirds or more of the total construction costs, which is why it is essential that they are stored and managed properly. Once purchased, stored materials can be kept on-site or off-site. This distinction is important because, depending on the location of the materials, the lender may prescribe different measures of assurances for their protection. Such measures, ranging from different models of insurance to regular inspections and additional assurances, can vary between lenders.
From the perspective of the borrower, purchasing materials in advance (and commonly in bulk) is beneficial because it reduces costs and enables a smooth, uninterrupted construction process. While it may seem that lower costs and efficient construction are in the best interest of all involved parties, the lender will wish to minimize the risk of any damages and losses to the stored materials and the resulting financial implications.
Lender Objective: Risk Management
As we already briefly mentioned, stored materials represent a major risk for the lender, which is why they are generally cautious about allowing funds for their purchase and tend to request a great degree of control over how the funds are used, how the materials are stored and insured.
The primary concern with stored materials is the risk of their loss, whether through physical damage, theft, or deterioration due to inadequate storing. Any such loss can have a dramatic impact on the construction project’s overall budget and may result in delays due to unpaid expenses, contractor disputes, etc. In order to protect its interests, the lender will often look to restrict the funds for stored materials and seek assurances that the materials are paid, accounted for, stored properly and protected from any losses. Such assurances may include:
- Insurance of stored materials
- Proof of ownership by the borrower
- A log of stored materials, sometimes including periodic photos of said materials
- Occasional inspections
- Storage in “trusted” facilities under specific conditions
- Time limits for the use of stored materials
Additionally, stored materials can complicate matters for the lender in case of borrower default, if there are any outstanding payments to be made to vendors, storage facilities, or other parties. To prevent such instances, the lender may require specific terms in the agreement that provide them with legal rights over the stored materials in case of a default.
Borrower Objective: Cost-Effective Construction
As an intermediary between the lender and the general contractor, the borrower will wish to secure an uninterrupted flow of funds in order to allow the contractor to purchase the necessary materials in a timely manner and at a favorable cost. Additionally, the borrower will look to minimize the costs of any assurances required by the lender (storage, insurance, inspections, etc.). Therefore, the borrower will have to negotiate agreement terms that allow financial flexibility and reasonable expenses for the management of stored materials.
The crucial points for the borrower will be limiting both the restrictions on the funding of stored materials placed by the lender and the lender’s requirements regarding their insurance and storage. This can be achieved through various terms, such as:
- Setting a cut-off total value of stored materials on which the restrictions can be applied
- More reasonable time limits for which materials can be stored
- Minimizing the amount (and thus the cost) of any assurances
- Allowing exceptions
Negotiating the terms for the stored materials and finding some middle ground between the lender’s and the borrower’s objectives is crucial for ensuring the protection of the best interests of all involved parties. The number of things to consider and monitor can be overwhelming, which is why it is always strongly advised to utilize a construction finance management software to easily track these timelines, restrictions, assurances and photos in one central location.