In the previous two blogs we spoke about mitigating risk during the construction lending process by knowing What to Look for in a Thorough Plan, Specification and Cost Review, and discussing Why Lending Professionals Must Have a PSCR Report Before Your Next Construction Project.
However, what does a lender do to mitigate construction-side risk when financing a structure that has already been built? Either prior to renovating an existing building or during the sale of an existing structure, knowing the current condition of the collateral is key to a successful lending transaction and while the answer is lender specific, one of the tools available for use is the Property Condition Report. A Property Condition Report (PCR) is an industry-standard compilation of current conditions of the key building components observed during a thorough field inspection and through a review of available documentation. The PCR can have varying formats but most often follows the ASTM E2018-15 standard. In this blog, we will review items lenders should pay particular attention to prior to the field inspection, and tips to understand the completed report.
In order to make the final report as comprehensive and valuable as possible, most consultants will supply the property owner with a building questionnaire which should be filled out and returned to the inspector prior to the field inspection. The information provided offers a frame of reference to the inspector and can assist in facilitating a more accurate assessment. This questionnaire typically includes property-specific information including: building square footage, site acreage, age, utility providers, structural component composition, etc. The reason for requesting this detailed information up front is to reduce the assumptions of building components not visible during the inspection. Additionally, the consultant will work to fill in any information gaps using third-party sources. Using information from these third-party sources is not ideal as the information received can be inaccurate.
Equally as important as the pre-inspection questionnaire, proper attention should be made to providing full access to all areas of the structure and site. Field inspectors will require admission to all sections of the building but most notably will need to see the mechanical rooms, office suites, residential units, basements, restrooms, common spaces, and roof. If areas are unable to have an inspection performed on them ultimately the report could be less effective because of the missing information.
One main objective of the field inspection and subsequent report is to assign a current condition as identified by the field inspector. The ASTM standard categorizes the condition of a building component into one of three categories. Those categories are:
- Good Condition – The component or system is performing satisfactorily. Normal wear and tear is visible. Maintenance and normal rehabilitation work may be required.
- Fair Condition – System is performing satisfactorily; however, one of the following may be present:
- Immediate or short-term repairs may be required; or
- Component or system is obsolete; or
- Component or system is approaching the end of its useful life; or
- Evidence or repairs that were not done in a workmanship-like manner or to industry standards.
- Poor Condition – Requires immediate repairs, replacement or major maintenance.
One main point to note, condition is determined not only by visual appearance but also by the component’s effective age and effective useable life (EUL). If a component such as a roof is currently operating satisfactorily but has exceeded its EUL, the condition will be identified as Fair or Poor based solely on how far past its EUL the roof is.
Commonly, the field inspection reveals condition issues on the property. These issues can be minor or major in nature but all will need to be corrected during the term of the reserve. As such, the report will provide recommendations to correct the issues based on the current and anticipated condition. The timing of these replacements is broken up into one of three categories, Immediate, Short Term, or Long Term depending upon component condition and age.
The placement of a remediation item in a reserve category can vary based on the type of remediation recommended. It is at the discretion of the report author as to where each corrective action lands. In addition to the recommendation, a cost is assigned to each corrective action. Costs are meant to be generic in nature and not the exact remediation cost as multiple factors could affect the final cost.
Reviewing the Report
When the lender receives the report the size and volume of information can make a thorough review a daunting task. As such, the ASTM format provides a few sections that aggregate the information allowing for an easier review by the reader. LCS recommends that the report should be reviewed in the following order:
- Executive summary – Front-end aggregation of the condition issues identified during the inspection. It provides a high-level‘snapshot’ of each issue.
- Physical Condition Assessment Summary – Spreadsheet outlining the condition of each building component. Also includes cost recommendation aggregation by component and recommended reserve timeframe.
- Capital Reserve Schedule – Spreadsheet that itemizes condition remediation recommendations. Identifies items, unit of measure, quantity, cost per unit and total cost. Identifies year correction should be implemented.
- Component Subsection – The report has 23 component specific sub-sections the have greater detail about each building component regardless of condition. These sections offer more information about specific components.
A complete and thorough Property Condition Report is a critically important tool to help mitigate risk any time lenders are preparing for a construction project. Each of the steps outlined above will help ensure that your PCR provides all of the necessary information you need in order to make an informed decision.
And as always….
LCS listens to your needs to develop products that are right for your transaction. Whether that be an individual appraisal, environmental or construction report, or a combination of services; LCS will meet your needs in the most efficient, effective way possible.
To learn more, reach out to Liz Mahoney, Director of Sales & Business Development today.