In the few years following COVID, church leaders were not focused on construction or physical plant expansion; rather, they were waiting for in-person worship attendance to fully recover.
Over the last 12 to 18 months, lenders finally began to see a significant increase in construction financing requests.
Enter the tariff war and the caution flags are back out.
Executive VP / National Manager, Faith-Based Banking Division
Cass Commercial Bank
Not unlike during COVID, the current uncertainty around ongoing tariff negotiations is causing mounting concerns about supply chain disruption, the timely availability of materials, and their price.
Further — although it’s always challenging to correlate the physical plant wish-list with a church’s borrowing capacity — cost escalation is making project planning even more difficult right now.
Indeed, uncertainty reigns in the current faith-based lending climate. Even so, some strategies are worth implementing regardless of the economic factors at play.
STRATEGY #1: Talk to the lender first
Throughout my 34 years of ministry lending — which includes more than $5.5 billion in loans to churches — the core advice remains the same: talk to the lender first. You are in a better position to develop a design concept once you know what you can afford to borrow, whether your sources of funding will include a capital pledge campaign, whether you have sufficient equity to support further expansion — the list goes on.
Too often, the practice has been to sit down with an architect and builder first to develop a rendering or an animation in hope of using it to jumpstart fundraising. Later, when the realities of cost and borrowing capacity are brought to bear, “value engineering” ensues and the design concept ends up getting scaled back. The risk of this scenario is exacerbated in times of escalating construction costs.
The best way to avoid having to reduce the scope of a vision which has already been cast to your congregation is to obtain a no-cost borrowing capacity analysis from a qualified church lender prior to engaging an architect or builder to draft a facility design concept.
STRATEGY #2: Select a highly qualified general contractor
Selecting the right General Contractor (GC) is of primary importance in managing a successful project. Doing so reduces the ministry’s risk of surprises.
Sure, it’s tempting to select a minimally experienced, charitably priced builder — perhaps from among the donor base — when the budget is tight and construction costs are escalating. Resist the urge. It’s better stewardship to select a GC that has deep experience with large commercial structures similar to what you will be building.
Such a lender is likely to require a Guaranteed Maximum Price (aka a Not-To-Exceed) construction contract to ensure that the church has minimum exposure to unanticipated cost increases.
Finally, ask the builder to provide a bonding capacity letter — a high-quality GC will be able to do so. Bonding capacity refers to the maximum amount of surety credit a contractor can obtain from an insurance company, based on the builder’s financial strength, experience, and ability to handle projects like yours.
Most lenders won’t require you to purchase a performance bond (an insurance policy guaranteeing the contractor will complete the project according to the terms of the contract), but taking the time to confirm the GC meets the insurer’s requirements for a performance bond — is “bondable” — is a wise precaution.
SCANNING THE HORIZON
Perspectives from the “front lines” of faith-based lending
Church Executive: Surely, church leaders are feeling the uncertainty related to construction costs. Are you fielding a lot of inquiries about the current ‘climate of concern’?
Dan Mikes: Frankly, the conversation rarely starts that way. Instead, what typically happens is that a church comes in with a request to buy a facility and renovate it. The budget they anticipated for renovation might have been around $200 per square foot to start with, but we’re closer to the $350 to $400 mark right now.
Because we’re in the market every day, we’re seeing that most churches are only in the early stages of understanding what’s happening in this regard. So, when a church comes to us singularly focused on the need for a facility and securing the funds to get it, we’re mostly trying to help them adjust their expectations.
CE: In your experience, how often are churches not talking to the lender first, as you advise?
Mikes: Most of the time; the process rarely starts with a conversation about borrowing capacity.
The more common scenario is that a facility becomes available for purchase, or a church wants to build something to meet their ministry needs, and they come to us.
Really, it’s fairly common for a church to get into a design concept, put up a rendering, or do an animation to show the donors. Then, when they start talking to a lender, they find out that they need to scale things back a bit. That’s why I’m like a broken record about the need to talk to a lender first.
CE: When you see church leaders needing to ‘walk back’ their building project vision with the congregation, what does that look like?
Mikes: Well, a church client we just met with yesterday decided to look for a smaller building. Originally, they were looking to buy and renovate a ‘big box’ for church use, to the extent that it would also offer options for local ministries to lease space.
After talking with them about what’s realistic, they decided to look for a smaller building and focus only on what it will take to accommodate the church’s needs, for now. If they can help local ministries later in their evolution, then — together — we’ll continue to look for that opportunity.
But in response to your question, the more typical scenario is the need to exclude a wing from the master plan and move its construction to phase two. This is especially challenging if it’s all under one roof line, in which case a church will often look at shelling in a portion of the structure and addressing the finish-out of that part of the building later.
CE: In your article, you talk about impending interest-rate-resets. Do you have an estimate of when these might start?
Mikes: We’re just now reaching the point where some of the loans that were made before rates ran up are approaching that reset.
CE: Are church leaders prepared?
Mikes: Generally, they have anticipated it. Typically, the churches we’re dealing with have a businessperson on staff who’s dialed in on all that.
If, for instance, the church’s loan is a 10-year term with an automatic five-year rate reset, the formula for that reset is in the loan documents. It’s also tied to a published index — usually, US Treasury rates — so they’re able to anticipate the reset adjustment.
Plus, everybody hears what’s happening on the evening news related to interest rates.
— Reporting by RaeAnn Slaybaugh
STRATEGY #3: Come to the table prepared
As a lender, my experience is that the key factors impacting borrowing capacity for churches have remained fairly consistent in recent times. Primarily, lenders want to see:
• Stable-to-growing core giving trends
• Stable management
• A demonstrated ability to debt-service
• A history of maintaining adequate operating reserves.
Lenders will typically want to see financial statements for each of the past four years.
The first point of focus will be the historic demonstration of debt-service capability. For example, if the requested amount of debt will require $100,000 per year in debt-service payments, the lender will want to see whether or not the church could have covered that payment in each of the prior couple of years.
The basic formula here makes adjustments to Net Income to identify “cash available for debt service.” For example, non-recurring contributions (such as receipts from a capital pledge campaign) will be deducted from the Net Income / cash available. Conversely, non-cash expenses — such as depreciation — or non-recurring expenses, such as rent (which will be eliminated once the new building is built), would both be added back to the Net Income. Per this example, the resulting cash available for debt service would ideally be $120,000 in the prior year (thus, a “1.2-to-1 debt-coverage-ratio”), and $100,000-ish two years prior.
Additionally, cash balances appearing on the balance sheet in each of the prior few years should equate to about 60 to 75 days of average daily operating expenses during those years. Maintaining an adequate operating reserve is an indicator of good leadership and sustainable management practices.
STRATEGY #4: Be ready for interest-rate resets
Within religious lending, the big change today versus a couple of years ago is a significant rise in interest rates. This has had an impact on the aforementioned debt-coverage-ratio analysis, making it harder for churches to qualify for as much debt as they would when rates were lower.
To better understand this escalation, it’s important to note that church loans are considered commercial loans, which — unlike a home loan — a lender must keep on its books for the life of the loan. This is because there is no active market for the resale of church loans.
As a result, banks prefer not to offer long-term fixed rates because the interest they must pay to their depositors is variable and can rise, thus potentially reducing (or even eliminating) the bank’s profit margin.
Consequently, many of the loans which were made years ago when interest rates were lower will soon face an interest-rate reset to a higher rate. Churches need to anticipate this increase in debt service, managing their expenses in the year prior to the reset so as to assure they qualify for the renewal of the loan.
The picture is clear: in the current environment, one of the biggest challenges facing churches and lenders alike is the difficulty in anticipating construction costs. Focusing on what your church can control puts you in the best possible position to weather the storm.
