8 Ways the Economy is Affecting Construction Costs

by Andy Burns on December 2, 2008

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?

{ 10 comments… read them below or add one }

Dee Regan 12.02.08 at 7:36 pm

Congratulations on your first blog - very impressive!

Mike 12.03.08 at 2:47 pm

Andy
Let me ask you what your feelings are in this economy on having your clients spend extra monies to have a new or remodeled building commissioned. Not from a LEED mandatory viewpoint, but from the viewpoint of hiring a set of trained professionals to performance test and document the MEP systems prior to the owner or tenant moving into the building.

Owners representatives seem to be split on the subject, some feel that in this economy spending extra to re-evaluate and test what the design engineers and contractors are supposed to be doing is a waist of money. Others feel that knowing the project is to be commissioned and an additional set of technical eyes, specifically dealing with the MEP systems, gives them the knowledge and confidence that before the owner occupies the building, the systems will be operating correctly.

Do you feel it is the owner’s representatives interest to suggest commissioning to their clients in the pre-design phase to allow the commissioning firm to be on board from conception through completion.

Andy Burns 12.05.08 at 9:46 am

Thanks, Dee.

Hi Mike:
Thanks for the comment. We are recommending commissioning to all our clients whether their properties are existing, remodeled, or new. And yes, we fully encourage our clients to consider all phases and aspects of commissioning: Retro-commissioning (for existing facilities that have never been commissioned); Re-commissioning (facilities needing tune-ups that had been commissioned at a prior time); Warranty-commissioning (this would be a short term monitoring program to assure ownership of performance and operations - and alert installation contractors of the need to fix problems), and; Continuous-commissioning (this would be an on-going structured program throughout the life of the facility).

We absolutely push our clients to understand the need for early intervention by qualified commissioning agents in the design phase (and throughout the project until acceptance) for any significant remodeling or ground-up project. We believe that pretty much every building is a one-of-a-kind environment and therefore establishing design requirements, and baselines of performance and expectations early in the design phases allows the A/E team to better integrate systems with the facility’s other programming goals. All too often MEPs are kinda plugged in afterwards - this is a bad approach and owners need to be educated to the simple fact that it will cost less, and be less disruptive, to fix a problem during design than during construction or after occupancy. We suggest all building systems be commissioned - but when budget issues limit your targets, the systems we aim for at minimum are: HVAC equipment & controls; Life Safety & Security system; Lighting equipment & controls, and; Electrical equipment & controls.

As to LEED - the project does not have to be a target for LEED certification to benefit from a smart commissioning program. Will be talking more about LEED projects here. Stay tuned.

Kevin 01.20.09 at 10:18 pm

Andy,
Thank you for the article. I would be interested in how the de-escalation/escalation clauses could be structured to benefit all parties.

Andy Burns 01.23.09 at 1:35 pm

Kevin:

Although the clauses can be bookkeeping nightmares - they are thought by some to be a very fair way of handling the contracting process - especially for projects of long duration. Obviously, the perception is that the escalation clause will benefit the contractor - the de-escalation clause the owner. There is alot to it.

You know what, you have raised a really good question that would warrant a deeper explanation than in a comment. New blog post coming.

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