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You are here: Home » Resources » Articles » Projects in Trouble: The Value of Cost-to-Complete Reports

May 7, 2024

Projects in Trouble: The Value of Cost-to-Complete Reports

By Robert L. Knight, AIA, LEED AP

Projects in Trouble: The Value of Cost-to-Complete Reports

By Robert L. Knight, AIA, Principal, National Client Manager, Partner Engineering and Science, Inc.; and Lisa S. Ward, LEED AP, CPC, CRE Loan Administration, Construction Management, J.P. Morgan

Originally Published in the 2024 CLRM Journal

Commercial construction projects, while promising great returns, also pose significant risks for lenders and investors. Unforeseen conditions, budget overruns and unexpected delays can quickly eat into expected profits. When things go wrong, a deep dive to evaluate what needs to get troubled projects to the finish line, along with related costs, can offer insights to help mitigate risks and steer projects towards successful completion.

Key Instances for Report Usage: Significant Project Changes

A Cost-to-Complete report is ordered when construction is underway and when there is a significant change on the project such as:

  • Change in General Contractor – When a general contractor has been terminated or ceases business operations.
  • Significant Impact to the Project Budget – Seen as cost overruns or an item that significantly affects the remaining budget.
  • Project is Stalled, Stops Work, or is Restarting – Project restarts place risks to both the schedule and budget.
  • The Project Adds or Changes Lenders or Investors – New lenders and investors on a project under construction evaluates their risk for joining an existing project.

It’s worth noting that while this article focuses on troubled projects, not all instances of Cost-to-Complete report usage are due to project distress (ex: new investors). Essentially, any substantial deviation from the original project plan or any event that could impact the project’s financial health or completion timeline may warrant the ordering of a Cost-to-Complete report.

The Role of a Cost-to-Complete Report

At its core, a Cost-to-Complete report is a comprehensive analysis of a commercial construction project’s financial status and future projections. It includes the following key components:

  • Current Project Status – A detailed overview of the project’s progress to date, highlighting completed milestones and expenditures.
  • Remaining Work – A breakdown of construction yet to be completed, including materials, labor, and any outstanding contracts.
  • Cost Projections – Estimates for completing the remaining work, factoring in current market conditions and potential contingencies.
  • Contingencies – An allowance for unexpected costs or changes in the project scope, anticipating for unforeseen circumstances.
  • Risk Assessment – An analysis of potential risks that could impact the project’s timeline and budget, along with mitigation strategies based on work completed and costs incurred.
  • Recommendations – Actionable steps based on the report’s findings, providing a roadmap for effective project management forward.
Preparation and Distinctions of the Cost-to-Complete Report

While a Cost-to-Complete report is like a Document and Cost Review report, a Cost-to-Complete is a more extensive evaluation of a commercial construction project. Since the project is already underway, additional work is needed, including a site visit, detailed review of pay applications to date, review of parties contracted to finish the work, evaluation of lien waivers and their completeness, and possibly a Contractor Evaluation report in the event the general contract has changed.

The preparation of a Cost-to-Complete report involves:

  • Site Visits – Experienced professionals conduct on-site inspections to assess the progress of the project, noting any completed work and ongoing activities. This allows for a more accurate evaluation of the project’s current status and potential challenges.
  • Documentation Review – Analysis of contracts, invoices, change orders, lien waivers, and other relevant documents provides a comprehensive view of the project’s financial history. A thorough review of these items will help identify discrepancies or potential risks that may impact the project’s budget and timeline.
  • Consultation – Discussions with project managers, contractors, and stakeholders offer valuable insights and perspectives into potential challenges and opportunities.
Benefits for Lenders and Investors

Cost-to-Complete reports offer several advantages for lenders. Firstly, they facilitate enhanced financial planning by providing accurate financial forecasting. This enables lenders to make well-informed decisions regarding budgeting and loan structuring, particularly in response to project changes. Secondly, these reports enable proactive risk management. Early detection of potential cost overruns or delays empowers lenders to take timely and proactive measures, such as adjusting loan terms or providing additional support. By minimizing the risk of unexpected financial burdens, lenders can ensure smoother project execution and favorable outcomes. Lastly, Cost-to-Complete reports aid in risk mitigation. By gaining a comprehensive understanding of the project’s financial health and identifying potential pitfalls, lenders can effectively mitigate risks, ensuring the successful completion of the project.

Developers and Sponsors Advantages

Similarly, Cost-to-Complete reports offer numerous benefits for developers and sponsors. Firstly, they enhance credibility. Providing a Cost-to-Complete report demonstrates transparency and reliability to lenders, fostering trust and confidence. This can be invaluable for securing financing and garnering support for the project. Secondly, these reports serve as effective project management tools. They offer insights that enable project managers to maintain cost and schedule accuracy, ultimately enhancing project efficiency and success. Thirdly, Cost-to-Complete reports empower borrowers with cost control measures. By identifying potential cost overruns early on, borrowers can implement timely corrective actions to keep the project on budget and on schedule. Lastly, these reports assist in project schedule maintenance. A clear and accurate assessment of the project’s timeline, including the date of substantial completion, is essential for borrowers. It enables them to prioritize and coordinate activities effectively, thereby minimizing delays and maximizing project efficiency.

Introducing a Real-World Example

The case study below sheds light on the challenges faced during a community development construction loan project, presenting examples of when these reports can be effectively utilized. The Cost-to-Complete reports played an important role in addressing these challenges and guiding the project towards successful completion.

Community Development Construction Loan Example

An urban project with a $12 million budget was planned with a reasonable contingency of 10% and showed promise to help revitalize an area of the city. The borrower-developer is based 1,300 miles from the project site and has no prior experience in this city. In addition, the general contractor is new to the borrower-developer and lender. Despite these factors, the original lender proceeded with the loan.

Six months into the project, the contractor’s pay applications continued to have issues including not receiving lien waivers from the subcontractors and inaccuracies on percent complete for the individual line items. Given that the project had about 10% of the total budget for allowances, which is typically a concern, these items were watched closely during construction.

It became evident that the allowances were insufficient to cover costs, prompting the general contractor to submit a $2 million change order to cover the difference. However, this exceeded the original lender’s budget, necessitating the involvement of an additional. Subsequently, a Cost-to-Complete report was ordered.

Six months later, the project encountered a setback when the general contractor declared bankruptcy. A second Cost-to-Complete report was ordered, accompanied with a Contractor Evaluation report on the new general contractor. Despite the fact that the schedule was impacted, the project proceeded with no work stoppages, and all subcontractors have been paid to date.

Although the project experienced an increase in the original project budget, an updated budget and schedule was established, with completion set for Fall 2024.

 

Conclusion

The Cost-to-Complete report offers lenders confidence that a project in distress has a higher likelihood of being completed. It provides lenders and borrowers a comprehensive analysis of the project’s status, and a path forward to completion by providing valuable insights for informed decision-making, timely interventions, and proactive risk mitigation strategies. As projects grow in complexity and scale, the value of this tool becomes increasingly indispensable, particularly when projects encounter stress, ensuring smoother project completions for all stakeholders involved.

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