An essential part of managing construction loan risk is to align invoiced work with the project timeline and budget. The work should also be performed to meet building code and consumer expectations. Many construction lenders lack the time and experience to evaluate the quality of work done by the builder. That’s why it’s crucial to know what to review in third-party construction inspections, as they are a critical part of a successful construction loan management program.
Often called construction progress inspection or draw inspection, a construction site inspection definition is best described as a review of construction work and progress to ensure the project is in compliance with the construction plans provided and in consideration with the size, worth, and essential items outlined in the plans. Third-party inspectors are certified and experienced in mechanical and electric codes, legal issues in construction inspection, concrete and masonry, and structural integrity.
We’ll share some of the elements of a construction site inspection report after we first look at the types of inspections and the stages a third-party inspector follows to complete a report.
Different types of inspections
There are five major site inspection types including a new construction home inspection, subdivision inspections, multifamily inspection, commercial inspection and site development inspection which deals with in-ground utilities, roads, signs and lights, sound barriers, gates, common areas like parks and parking lots. Also, site development inspections are often conducted during the other inspection types as well.
Inspector Workflow
So what are the steps an inspector will go through to ensure the project is running smoothly, in compliance with the construction plan, and to create a detailed report?
First of all, the inspector will receive a copy of the draw package requesting payment from the borrower, the contractor, or the bank. Upon obtaining all of the necessary documentation, the inspector will review the draw records, past and present, to gain an in-depth understanding of the state of the project – the timeframe, the construction schedule, and the scope of work completed thus far.
Related: Three Example Issues Uncovered by a Third-Party Draw Inspection Report
An on-site examination of the construction project is the next step after reviewing the documents. The inspector uses a construction site inspection checklist to examine and verify the progress of the mechanical, plumbing, and electrical phases of the project as well as an assessment of framing, roofing, drywall, sheathing, and more. The inspector will then submit a construction site inspection report verifying or disproving the viability and accuracy of the draw request. The inspector will also include funding recommendations in the report.
In some cases, there may be a need for a construction dispute inspection where the third-party inspector is called upon to produce an unbiased report that will settle any disputes between contractors, lenders, and customers.
Top eight items for construction loan managers to view in third-party inspection reports
- First of all, photos of project completion to date should be obtained and reviewed for accuracy. The lender needs to confirm that the inspector went to the correct construction site (yes, mistakes like this can happen) and then compare photos to prior draws to verify tangible progress.
- Step two is to review the hard costs and retainage balances. This review helps the lender determine if the project costs to date match the original contract sum and if they seem reasonable based on prior requests and disbursements. The lender will also check to see if the retainage percent (e.g., 10%) matches the contractual amount to date. While conducting a funding analysis, the lender will check for any significant input errors between the draw funding line items and the G702, as well as checking to ensure that the provided receipts are correctly associated with the project and tallied to confirm total. It’s crucial that lender also reviews loan-specific thresholds for percent complete vs. percent invoiced.
- Next, it’s time to scrutinize the percent of the project completed and percent of contingency used to date. The lender should review the list of prior draw requests to see the percent completed over time, looking for increasing percent completed each period. When it comes to contingency funding, most construction projects use a rate between 5 percent to 10 percent of the total budget to determine contingency. Typically that amount will cover any extra costs that might come up. It is therefore essential to review the line item for contingency to make sure the appropriate amount is set aside at that particular phase of the project.
- Next, a review of current hard cost revisions based on change orders helps: a) assess if the costs associated match the original change order, b) asses a change in scope of work, and c) determine how these changes affect the overall budget and timeline. It’s essential that the change order matches the nature of the work before sending the inspector to the site.
- If the project is behind schedule, it’s essential to determine by how many weeks and to review the funding schedule line chart that shows both ahead of schedule and behind schedule funding. If the project is behind schedule, calculating the interest reserves lets the construction loan manager know if there is enough interest to pay out if the project goes over the schedule timeline.
- Are there any long-lead time or off-site stored materials from the G703 document? Stored materials relate to items purchased in advance and are stored either on a project site or at a different “off-site” location. You can think of off site stored materials as anything that the builder cannot run down to Home Depot to grab because it is specific and custom to the project. They include things like framing materials, roof trusses, custom timbers or beams, HVAC equipment, and custom windows, all of which should be safely stored in an insured facility close to the project site.
- Is there sufficient budget remaining (including retainage) to complete the project? To determine this, the list of prior draw requests, amount approved, retainage percent, percent requests, and percent complete should be reviewed to determine if the percent completed each period is increasing and matches the overall scheduled project timeline.
- Determining the lien release status means verifying that lien releases match to the point within the construction process. If $1Million has been funded, then you’ll want a release, either conditional or unconditional, to balance to that amount. This status check is done to prevent the risk of any missing liens slipping through the cracks. It is also essential to determine if the general contractor has provided an unconditional lien release from prior draw requests with language stating that the general contractor has paid all obligations concerning those payment applications.
In conclusion
Performing a third-party construction site inspection is extremely important regardless of the nature and scope of the construction project. A highly skilled and certified third-party inspector is a critical resource that will vouch for the work completed, and deliver a detailed construction inspection report that both identifies concerns and helps to move the project forward. Knowing how to read and interpret the report is a critical construction loan management skill.
About Rabbet
Rabbet provides process automation software to mitigate risk in construction loans. By reading documents, coordinating approvals, and tracking payments, our software creates efficiencies and identifies opportunities to limit exposure for construction lenders and borrowers. Built in Austin, Contract Simply’s award-winning software cuts days from the construction back-office operations while ensuring compliance and reduced liability for everyone involved. Get started with a live demo today or check out our overview video.
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