Defensive construction lending — what a lender needs to know before making a construction loan

August 6, 2024

Construction lending can be risky for various reasons in the best of economic times, and even more so with the backdrop of a weak or down-turning economy. Projects may struggle to become successful, particularly in a sluggish economy, potentially resulting in a failure to complete the project or retain its viability. Such failures can adversely impact the associated borrower's ability to repay their loan. It is important, therefore, that construction lenders identify the market and other risks associated with potential construction loans and adopt a course of conduct aimed at achieving timely payment thereof based on the particular project, the borrowing entities and the economy. To offset potentially heightened market risks, a construction lender should make every effort to limit the non-market risks inherent in construction loans, setting up the borrower and the project for successful repayment of the loan, regardless of the state of the economy.

Few construction lenders have the opportunity to consistently make construction loans to high credit entities or on commercial and industrial properties fully leased to lessees with high credit ratings. Construction lenders can, however, engage in a variety of strategies to ensure a project's attractiveness and success such as:

• intimately knowing their borrower and guarantor/s
• pursuing cautious and diligent pre-commitment investigation
• drafting and reviewing their term sheets with great care, including consideration of any potential requirements under the loan and attentive administration of the loan

This article discusses each strategy in turn.