Building with Confidence

Incredible growth can come when a congregation and its leadership break ground on a new building. But those same exciting times can also be times of great stress, sometimes even splitting a church if things do not go well.

Construction and its financing are complicated, and many well-seasoned church leaders find themselves in over their heads when things start to go wrong. Educating yourself on the entire process prior to beginning construction, or even finding financing, can be instrumental in avoiding problems.

This article describes the various steps of the process, pointing out specific areas that should be considered when planning any building project.

Before an architect draws the first line on the blueprints or the builder lays the first brick of your future building, it is essential for church leadership to carefully analyze the vision and planning process for the entire project. Because obtaining financing to build a new facility can be one of the most challenging decisions for a church, strong consideration should also be given to the other options available to acquire space. There are four ways to acquire new facility space:

An appropriate lease, with suitable terms and reviewed by legal counsel, can be a good way for a church to expand its footprint without having to spend the time and expense of obtaining financing and building a facility.

Another option that should be given strong consideration is the availability of existing properties/facilities in your area for purchase. Purchasing an existing facility may be advantageous because, among other reasons, renovations generally will be less expensive than new construction, require a shorter amount of time to complete, and often entail less government involvement. In addition, while the cost of construction continues to increase, there has been an increasing availability of foreclosed or otherwise vacant commercial properties nationwide.

Key considerations with any existing facility available for purchase include:

Expansion of a current building may remove the cost of new real estate, but building and financing costs will remain. Also, when choosing to expand an existing building, your church may be surprised to learn that certain building codes or zoning regulations have changed. Many churches do determine that expansion is best, and often design their new buildings to plan for expansion in the future.

If the church’s leadership team has evaluated the time and expense associated with new construction and the leadership is determined to pursue financing for new church construction, you will want to make sure that you have engaged in the proper vision casting, strategic planning, and evaluation to ensure your congregation is fully behind you.

You may want to consider assembling a building planning team and a building finance team to evaluate your church’s congregation size and potential growth, ministries, current facilities, current financial condition, and possible ideas for new construction/facilities, including parking, preliminary construction funding/financing, and cost estimates.

Be realistic about the expansion project and the level of congregational commitment. Will a majority of the congregation commit to financially support the expansion if it hasn’t already? Will the church implement a stewardship or capital campaign? Keep in mind that there are firms that specialize in assisting churches in meeting their financial goals and objectives for new church construction.

Generally, building campaigns should be enacted 12 to 18 months before any anticipated new construction starts and frequently will not begin in earnest until after the initial architectural renderings and preliminary project costs have been determined.

When assessing your current situation and anticipated needs, as well as the possible required financing, be sure to anticipate and build in cost-overruns—whether resulting from “change orders” or otherwise.

“Change orders” are discussed throughout this article and are important to properly understand. In general legal terms, a “change order” is a modification of a previously ordered item or service. Change orders are important to anticipate because they are a leading cause of increased prices, unforeseen delays, and cost overruns. It is not uncommon for overruns to be 10 percent or more of the total cost of a building project.

These additional change orders must be carefully accounted for in the church’s construction legal agreements and throughout the entirety of the construction process. After the appropriate vision casting, strategic planning, and evaluation have been accomplished, you will be ready for the next step.

The best way to obtain the congregation’s approval for the leadership’s new strategy is different for every church. But in a construction project, following governing documents to a “T” is absolutely vital.

It’s possible for church bylaws to have special voting procedures for construction, real estate purchases, or obtaining debt that do not apply to other large decisions, such as hiring a senior pastor. Do not assume you know what your church’s bylaws say without thoroughly reading them. And if there is any question as to what the bylaws say, contact an attorney. Your members and any possible lenders will want to be absolutely certain you followed the process your governing documents require.

Many words in your articles of incorporation and bylaws have a legal meaning that need to be understood. Even “Trustees” and “Directors” may have different legal duties and even different levels of personal liability. Take the time to figure out who is ultimately responsible for your church’s transactions.

If your church’s governing documents require the congregation’s vote to move forward with the transaction associated with construction (i.e., debt, real-estate purchases, hiring of a contractor), it is important to follow the process established by your bylaws or articles, and to document the process. Our legal firm has seen multiple churches that did not document any vote and say, “Well, our bylaws do not require documenting the vote.” Even if your bylaws do not require documenting a vote, state law or a lending bank likely do. Not documenting votes made in accordance with your governing documents is poor governance.

To ensure a proper congregational vote, pay attention to things in your bylaws such as:

If your church has never pruned its membership roll, and you have a thousand people on the roll who no longer attend, it may be difficult to achieve an affirmative vote if, for instance, your bylaws require 66 percent approval of “all voting members.”

It is also important to pay attention to the language the congregation or board is approving. Resolutions for approval should include:

Many churches that are governed by a board of directors, and do not require the approval of their members for a building project, still choose to have their congregation give an informal approval for construction projects.

While the informal approval may not be legally binding, this sort of procedure allows the board to determine whether the members have the desire to pursue a building project. If a larger percentage of the members would not support a construction project, or a building campaign, the board may want to consider other possibilities.

Obtaining financing to purchase an already-completed structure is relatively straight-forward when compared to new-construction financing, which can be one of the most challenging decisions and processes a church will ever make. At times, it can feel as if the church is trying to hit a moving target. A possible scenario could look something like this:

Sound extreme? This can and does happen, which is why churches need to ensure an orderly preconstruction process. It’s impossible to have absolute certainty about the cost during the preconstruction phase, so churches should work with experienced church law and construction experts to protect the legal and financial interests of the church.

Until the design and other preconstruction issues are finalized, churches will not be able to engage in discussions and negotiations on the primary terms and conditions of any loan, because most construction loans are established as interest-only loans where the church will pay interest only on the draws that are made and not, initially at least, on the total amount of projected construction costs.

Steps churches can take to ensure construction projects are accomplished as smoothly as possible are:

This is particularly important, especially if a church plans to take out a loan. The best type of lender for this is often one who has experience working with churches and their unique needs. A local lender who is already familiar with your church can be helpful. A bank that is already familiar with your cash flow will be able to more quickly advise you on potential terms and conditions for your loan—including any lending limits and other constraints. However, be sure to get loan information from other banks and commercial lenders to ensure you are getting a competitive quote.

The qualification process to select a lender takes time; plan on starting this process at least three months before the anticipated construction start date. We recommend selecting a lender at least two months before the anticipated construction start date. The involvement of the senior pastor and other senior leaders is important at this early stage. Remember: the bank is trying to determine if it will enter into a long-term partnership with your church, which includes your pastors and leaders.

Also, be aware of the material distinction between a quoted rate, which may or may not be available when you actually need to take out a loan, and a locked rate, which is guaranteed in writing by a bank official and binds the bank to use that rate for a specified period of time. Generally, a locked rate will require the submission of a greater number of financial and other documents.

Prepare several preliminary documents to make the process as smooth and efficient as possible. The following preliminary loan documents should be sufficient to get a term sheet or preliminary expression of interest letter to allow you to select a lender:

A performance bond is an additional front-end expense, but it can greatly reduce the risk of additional costs due to errors in construction and/or construction defects. Performance bonds generally come into play when there are delays in performance or substandard performance.

This is first-party insurance that covers loss or damage to the uncompleted building and materials stored at the site. Consider also purchasing Owner’s Professional Protective Indemnity Insurance, which insures specifically against design professional negligence.

The following financial instruments may be used to achieve your lending requirements:

Your church will be required to obtain a commercial appraisal.

Appraisal costs vary based on location and property size, but be prepared to spend anywhere between $800 and $5,000 for a limited or restricted appraisal, or up to $10,000 for a full commercial appraisal.

There are many reasons why some church appraisals are so expensive, including the large, single use nature of most church buildings coupled with the general lack of comparative data— depending on the location of the church.

Prepare to navigate restrictive covenants that exist in many communities that may affect church construction.

A restrictive covenant is a provision in a deed which restricts the manner in which the property may be used. Because this issue is dependent on the situation in your church’s local community, it is imperative to engage legal counsel to determine the extent to which and how early in the process you will need to address this issue.

Generally, any restrictive covenants or other zoning issues must be resolved before securing financing and engaging in construction activity. The federal Religious Land Use and Institutionalized Persons Act (RLUIPA), which gives churches and other religious institutions a way to avoid burdensome government-imposed zoning restrictions on their property use, can sometimes be helpful to churches in resolving zoning disputes.

The RLUIPA also defines the term “religious exercise” to include “any exercise of religion, whether or not compelled by, or central to, a system of religious belief.” Experienced legal counsel can facilitate communications with governmental authorities regarding zoning issues and assist in resolving some before they potentially derail a project.

Environmental issues such as lead, asbestos, and lead paint can also delay your construction project, especially when renovating an older building.

Banks and other commercial lenders typically require a “Phase I Environmental Study” to be completed on an expansion/construction site. This study is done by a professional engineer and assesses the environmental impact due to the construction, even if you have owned the property for a long time. A Phase I study, which is the most common, will involve soil borings, an analysis of the water table, and the exploration of other environmental concerns.

If your church’s property has previously been used as a gas station, gas storage, lumber treatment facility, or a dry cleaner, it is possible that the Environmental Protection Agency will require further testing to ensure its standards are met. These sorts of clean-up costs can sometimes exceed the cost/value of the property, although there are federal and state remediation programs a church can apply to for assistance with cleanup. The environmental issues can also invoke wetlands-related issues and require permitting from the US Army Corps of Engineers.

Other costs and fees can include the following:

Once your church has decided to pursue new construction, and appropriately approved the project, it is time to consider the method by which your church will pursue that construction. This is the step where your church will involve professionals like bank loan officers, architects, and attorneys.

This step is also strongly influenced by and intertwined with the financing step (discussed earlier), as your plans and specifications for a new facility (or refurbishing/renovating an existing facility) will be dependent on how much can actually be spent. Within this step, you have a fundamental choice—namely, which method of construction will you utilize? Keep in mind you may have an architect or construction firm (or several already identified) who does not utilize all potential options.

The three most common methods of construction are:

Regardless of which of the foregoing options is selected, church leaders should not start construction until they have a design they are comfortable with, can afford, and they know how they are going to pay for it.

For most substantial construction or renovation projects, the church must have an owner’s representative onsite periodically to check on the progress of the work and confirm that purchased materials are actually onsite. Usually this person is a construction professional or retired builder or contractor—someone who is knowledgeable about construction and functions as the trustworthy eyes and ears of the church. This person will document and report progress, watch for problems and potential changes that the church may need to address. If the church does not have this person onsite periodically, then it is solely relying on the contractor’s integrity and greatly increasing its risk.

It’s a good idea to factor in the owner’s representative as a paid position to the church’s total cost for the project. The general rule is that 1 to 3 percent of the total construction cost is paid to the owner’s representative, but this amount can vary depending on how much time onsite is required and the scope of authority the individual is given.

Our firm’s experience has shown that trying to cut costs in this area—by, for example, using an experienced volunteer member of the congregation who is not financially tied to the project—is a recipe for disaster and can cost the church far more in payment of attorney’s fees for litigation and lost time and materials. Hire an experienced professional, who understands the construction project and the industry, to routinely be onsite protecting the church’s interests and oversee construction or substantial renovation projects.

Plans and specifications that are developed include documents detailing the timeline or critical path for the construction project. These documents are often posted in the contractor’s construction trailer, allowing the contractor to provide an estimate of the need for the project’s funding.

Payment is not made all at once in advance or upon completion of the project, but rather upon presentation of a draw request as the project progresses. Often, the first draw request is to pay the architect and engineer’s fees. Additional requests may be to pay for specific tasks such as site preparation, completing the foundation, and so on.

Churches should understand the draw schedule so that costs of construction and progress can be monitored. For example, you don’t want to pay out 80 percent of the cost of the building when only 30 percent has actually been completed.

Be sure to check that the construction documents reflect the understanding between the parties. Churches will be required to make timely payments as the building or construction progresses, or to timely file a contest to the payment per the terms of the specific contractual arrangement. Failure to pay on time, or to timely file an appropriate payment contest, can potentially result in substantial penalties. An owner’s representative is able to assist in monitoring the draw schedule and ensuring timely communication of any issues that arise throughout the project.

The draw schedule is also often where the issue of retention appears. Retention is a provision allowing the church to hold back a specific amount of funds (retainage) for a specified period of time to ensure the work is being, and will be, completed according to the terms of the contract. It is common to see at least 10 percent being withheld from each progress payment or draw until the construction or substantial renovation is completed.

If the work has failed to meet the contract specifications, then the retainage can be used to correct the problem (or can be used as leverage with the contractor to get the problem corrected—nothing speaks as loudly as money when trying to get the project completed). Most states have a statute that if an owner holds back 10 percent of the construction funds—until all the work is finished and verified—that it significantly reduces the owner’s liability to subcontractors by providing an affirmative defense to lawsuits from unpaid subcontractors.

Construction contracts should include a provision that expressly provides the final draw or “retention” will not be paid out until the punch list items and certificate of occupancy/occupancy permit is issued. Most lenders will require at least 10 percent retention.

Despite what may seem to be common sense, our law firm still faces situations where churches either have already begun construction or are seriously contemplating beginning construction without a written contract. More often, our firm sees churches proceeding with a bare-bones written agreement that has almost no legal effect and fails to protect the church and/or define the rights and responsibilities of each party to the contract.

Either scenario is inadequate, and leaves churches almost totally relying on the integrity of the contractor and subcontractors involved in the construction. Be sure your church has signed written agreements with the architect, engineers, and contractors. Each agreement should be drafted and reviewed by experienced legal counsel. At a minimum, the agreement should address the following areas and issues:

Additional tips and considerations are as follows:

It is common and generally preferred to use “standard industry contracts” from organizations such as the American Institute of Architects (AIA), the Associated General Contractors of America (AGC), the Engineers Joint Contract Document Council (EJCDC), and the Design-Build Institute of America (DBIA).

Be especially wary of contractors who are not utilizing standard industry contracts. If a nonstandard contract is used, it becomes even more important to involve experienced legal counsel. However, even though AIA and DBIA contracts are commonly used, churches still need to be aware that no contract is really “standard” in the sense of being one size fits all.

There are many different options within each so-called standard form, and experienced legal counsel can assure the church’s interests are being protected as much as possible. There are many opportunities to allocate risks and define roles and standards of performance. So, if you are presented with documents and communication such as, “Here’s our standard contracts,” or “It’s just boilerplate stuff,” or words to that effect, you might ask yourself what trade group drafted these contracts and for whose benefit were they drafted.

If all of the other steps have been accomplished and sufficient attention has been paid to the details, construction should go well. The end goal is generally to obtain a Certificate of Occupancy (also known as an Occupancy Permit) from the local building inspector. As long as the building meets code requirements and other regulations, your church should be cleared for worship in your new facility.

You will have to ensure adequate maximum occupancy, mark all building exits, ensure adequate fire extinguisher protection, and other safety measures before the Certificate of Occupancy will be provided. However, before you get to the Certificate of Occupancy, you will need to manage the construction step well, ensure great communication, and be sure to follow the legal documents governing the construction.

A final checklist of items as you proceed through the construction process is: