Mitigating Financial Risk During Construction Comes Down To Communication

Construction costs continue to rise in 2017. The Turner Building Cost Index, which measures costs in the nonresidential U.S. market, increased 1.18% in Q2, a 4.96% year-over-year increase from Q2 2016.

Preventing cost overruns, already a high priority among property owners, is critical in a real estate cycle with a growing cost of labor and materials. Addressing risks before breaking ground is one of the most effective ways to keep a project on schedule and on budget. 

Reducing the amount of financial risk during a construction project starts with selecting an architect and contractor with the right kind of experience for the project, Baker Tilly Firm Director Tony Ollmann said. Construction documents should also be as complete as possible before going to bid. The more detailed the documents, the more precisely a contractor can bid on a project, which will minimize future change orders and surprise expenses.

The entire team should also know the ins and outs of the contract. 

“Too often we have discovered that the owner understands their contract well, the executives from the construction company understand the contract well, but not enough of the daily project management personnel intimately understand the contract,” Ollmann said. “There can be terms in the contract that impact the kinds of decisions that happen on a day-to-day basis.”

Good contracts should be fair to both the owner and contractor. Terms should clearly address all parties’ responsibilities for project delivery and how change orders will be documented and managed, as well as how reimbursable costs will be treated. A contract cannot address every construction site or cost event, but it should define the most common items, like labor costs, equipment rentals and general conditions with sufficient detail and support to minimize misunderstandings.

Failure of both parties to work through these specific terms and avoid generalities could result in conflicts and cost overruns down the line. 

“Owners should use experienced construction attorneys, accountants and consultants when evaluating contractor proposals and contracts to minimize misinterpretation of commonly understood industry terms such as cost of work, allowable reimbursable costs and subcontractor default insurance,” Ollmann said.

Holding a kickoff meeting between the owner and contractor can be a simple and effective way to work through the contract before breaking ground. Meetings not only set expectations for the contractor, like monthly or weekly progress reports, but also create an opportunity to address specifics within the contract. This ensures the terms most important to the owner are highlighted. A kickoff meeting gives owners the opportunity to explain to all of their construction development partners what they are looking for.

A well-defined and understood contract becomes a reference throughout the construction process, especially toward the close of the project when owners must satisfy specific requirements. Developers planning cost segregation analysis or who need to certify their construction costs for tax credit compliance should communicate these needs to the contractor.

Communicating these needs early in the project will facilitate collecting the necessary information from the contractor in a timely and easy manner. Owners that plan to utilize tax credits or cost segregation programs will require detailed construction cost documentation and early contractor communication of these documentation requirements will facilitate program compliance. 

Successful projects, Ollmann said, are the result of hard work and extensive planning, as well as good contractors and owners who take the time to communicate their needs and expectations. Owners need to stay involved in their projects, be candid with the contractor and be fair in their contractor dealings.

Contractors who treat their owners like business partners, share knowledge, provide good ideas and actively listen are widely recognized for delivering some of the best projects. Risk management is everyone’s responsibility, and when it is integrated into the real estate development life cycle, owners and contractors realize projects that are on time and on budget.

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