December 21, 2016
By Sundip Patel
Guest Contributor, C-Suite Wednesday
C-Suite Wednesday — 7 Proven Ways to Minimize Your Risk on Hotel Construction Loans
Hotel construction loans can be extremely lucrative, but their profitability comes with risk. These large projects have many variables and moving parts. Here are 7 critical actions you should take to avoid common pitfalls:
- Underwrite the general contractor on the project.
In addition to thoroughly researching the borrower and proposed hotel location, a third layer of underwriting deserves equal scrutiny – the General Contractor.
The GC company should have experience, solid financial capacity, good insurance and excellent references.
- Ask questions pertaining to the construction schedule.
Your GC should tell you what other projects they’re handling while working on your hotel. Those projects will compete for their time. The same is true regarding key tradespeople.
- Use a Cost-Plus Contract with your General Contractor.
A Fixed Fee Contract offers limited oversight. Instead, use a Cost-Plus with Guaranteed Maximum Price Contract, which requires the GC to be transparent regarding all costs and sub-contractor bids.
- Give fund control to an objective third party.
A fund control company conducts site visits for you during the construction process to check that the work being billed has been completed. Acting like an escrow agent, they review every invoice, ensuring you don’t disburse more than the project requires at any one time.
- Assign your own personnel to the project.
Members of your staff should visit the construction site every 45-60 days to track work completed and verify that franchise specs are being met. They should also attend all progress review meetings, whether in person or by phone.
- Withhold contingency funds until the project has reached at least 50% completion.
Keeping tight reins on contingency funds forces the borrower to be fiscally disciplined. If unexpected situations arise that require funding, the borrower is responsible for them until that 50% threshold has been reached.
- Carry adequate insurance.
Hazard insurance is a necessity during a construction project. Get dollar-for-dollar coverage for at least all hard costs (materials, labor, building, FF&E).
Problems in the construction of a hotel can result in expensive lessons. By following the seven guidelines listed above, you can avoid costly mistakes and make hotel loans with confidence.
Sundip Patel is the founder and CEO of AVANA Capital, a nationwide commercial real estate lender based in Glendale, Arizona. AVANA offers hotel financing through conventional and SBA 504 lending programs for acquisition, refinance and construction. AVANA also provides interim and bridge loans. Since its founding in 2002, the company has funded more than $850 million in loans. For more information, visit www.avanacapital.com.