8 Ways the Economy is Affecting Construction Costs

Greetings and welcome to our blog at The Burns Companies. I’m Andy Burns, the founder. Our goal with this blog is to help our clients through this challenging economy by talking sense about what’s happening in their construction projects across the United States. We’re a consulting company that acts as owner’s representatives for our clients in large commercial and multi-family construction projects. We’ve seen it all. And we play in the middle, helping our clients coordinate large projects in the most cost effective, timely manner. We’ll be dishing all about that here, along with other interesting topics as we come across them.

Lately we’re seeing how the economy is affecting all construction projects in one way or another. Recently, I was asked by one of my clients to comment on construction costs. His question was: “given the dramatic drop in oil prices and sudden lack of demand for new construction projects…”

And we thought that starting a conversation here would be a good way to explore how we see construction costs being affected by our economy. Let me know if you agree or disagree with what we are seeing:

1. Toss the Old Construction Cost Data Books.
Unless you subscribe to streaming RS Means Building Construction Cost Data or have a crystal ball, construction budgeting is more of an Art than a Science than it has EVER been. Pricing and cost control is a “boots on the ground” process these days – requiring us to attend frequent meetings with contractors, subs, and material suppliers to go over all costs on an on-going basis.

• For example: The price per pound of prime scrap steel recently dropped from 35 cents to 6 cents in 8 weeks. On one of our projects the original demolition contract negotiated went from being a net payment to Ownership (due to scrap steel value) of about $600,000.00 to a payment from the Owner of some $1,000,000.00. On another project from bid time to commencement copper went from $3 per pound to $1 per pound, resulting in an opportunity for significant electrical scope savings. The markets are so uncertain that if projects that have been bid do not proceed immediately we are having to re-bid the work just to be certain we have the latest pricing. If you don’t take the time to do that, you could be paying more than what you should be paying.

2. Contracts Need to Include De-Escalation Clauses.
We are advising the inclusion of de-escalation clauses in contracts, along with escalation clauses. Much of this makes for an increased, but necessary, bookkeeping effort. On a recent site work project, in a matter of weeks from contract signing, liquid asphalt rose dramatically from about $350/ton to $600/ton (a 67% increase). However, by phasing the project we are able to take advantage of a very recent decrease in the liquid asphalt price – although it still lies above the contracted allowance.

In fact, a recent article (requires an account or view PDF here) in the Banker & Tradesman noted that it is getting cheaper to build, and it could be as much as 10% decrease on total project costs.  The article noted a Boston project that was $450M could be decreased by $50M, now costing $400M in this economy.  Now that’s something worth revisiting.

3. Competition is Fierce, Material Markets Uncertain
Fees and profit margins are being cut by the contractors we are dealing with. Competition is getting fierce for any “real” project. The form of Contract (ie: stipulated sum, cost plus a fee, etc.) must be evaluated carefully by each Owner/Representative Project Team given the uncertainty of the labor and material markets.

4. Tight Credit Markets are Straining Relationships
The financials of all parties are receiving much greater scrutiny than ever, as are the contracts for construction. There are reports throughout the industry of projects that have been suddenly stopped, mid-construction, holding up payments due, and putting contractors, subs and material suppliers in financial jeopardy. This situation has created a tension and certain dynamic of mistrust amongst Owners, Lenders, and Contractors we have rarely seen. Someone is needed to be in the middle to help facilitate the next steps between the parties, and find creative ways to get these jobs done.

5. Change Orders Need to Be More Scrutinized
Change Orders are receiving much more scrutiny on our projects. This goes directly to first making certain that all A/E plans and specifications are reviewed and vetted completely for constructability and coordination issues. We like to remind all of our clients and anyone reading this that (other than in some cases of design/build contracts) the Owner is first in line in responsibility for misinformation in the plans that may lead to extra costs. Remember that Change Orders have always been a profit center for the smart “low bidder” on any project. And in this current climate, vigilance is required on the part of the Owner/Representative Project Team when it comes to claims for extra pay.

6. Anticipate Payment Defaults
We are advising Owners to be aware and take steps to guard against payment defaults by contractors, material suppliers, and subs – and to have a plan in place to handle this eventuality. This is an unfortunate reality for project Sponsors and Owners. It is important to stay ahead on payments; obtain lien waivers, and get signed releases from all tiers of project providers. Make sure contractors are not “front loading”, along with making sure that payments are only made for “work in place” is required.

7. Performance & Payment Bonds Are the Rule Now
Requirements for Performance & Payment Bonds are the rule rather than the exception now. This adds cost to projects and should be evaluated by each Owner/Representative Project Team.

8. Mitigate Project Risks with an Experienced Owner’s Rep
Working with an experienced Owner’s Representative in this climate will ensure that your project is well managed, stays in budget and on schedule. We often see that clients cut back on projects, take on the ownership and responsibility with all these moving parts, and end up paying much more in the long run. There are too many back doors that can increase project costs when the market is unstable. In our work, we find that a methodical approach to project management helps mitigate risk, reduce costs, and save time over the course of a project. It is strategically important that each construction project is proactively managed to evaluate and manage costs on a continuous basis, assure that key milestones are achieved, and push to complete projects within established time lines.

So, those are just a few of the things we wanted to share. How does this stack up to what you are seeing?

Tagged as: banker and tradesman, commercial construction, commercial development, Construction Costs, Economy, real estate development