Great Opportunities and Big Risk for Owners In Construction Projects 

Construction is on sale. It’s a great time to build; projects can be built for 25% less cost than 18 months ago.  Competent crews and materials are readily available.  We’re talking about great potential for on time delivery at bargain prices, in an industry that is regularly satirized for broken promises and price gouging.  Everything is great, right?  If you take the right precautions, it can be.

When the floor dropped out about 12 months ago the industry overly discounted itself.  I routinely see contractors that, I believe, have bid well below true cost.  Their actions are either unintentional as a result of bad estimating, or intentional because of their desperation for cash flow The potential to be engaging with a contractor who lacks basic competence or a contractor in a debt spiral should be an enormous red flag for owners.  Sometimes though, the bids look like an unbelievable bargain, and, often they are.  I’m watching several of those projects spiral out of control from a safe distance. 

With the deep discounts come huge risks for owners.  I’ll explain some of the risks and what you can do to protect yourself while you take advantage of the big sale.  

All of the profit has been drained out of the supply chain (general contractors, sub-contractors and suppliers) and the design chain (architects, engineers and manufacturers representatives). Consequently there is 0 margin for error. Anyone who’s been through a construction project knows this a business of problems.    When the project is running smoothly, the problems get solved through the normal reconciliation process that takes place between the design professionals and the builders.  Reconciliation comes at a price.  Most builders and design professionals historically build some room into their fees to be flexible and for the sake of being reasonable with one another. When there’s some money on the table, issues tend to get worked out.   When no party has retained any contingency at all, being reasonable becomes much less important.  The various parties tend to resort to hard lines in the sand with one another. It’s not just between the builder and the architect; it’s also between the builder and their sub-contractors, the sub-contractor and their sub-contractors, the sub-contractor and their suppliers, the architects and their engineers….. 

When everyone is bidding to work for free the builders and design professionals see their contract responsibilities in very black and white terms.  Builders won’t agree to have contemplated anything that’s not 100% documented.  Design professionals have to get paid for extra time to document differing field conditions, produce field reports and sketches, especially when their sub-consultants are involved.    

As an owner, once this polarization begins to take place, your project is at risk for slowing down or potentially stopping. “Extra Work” typically requires authorization and without quick authorization the jobs idles.  The decisions you make to keep the project moving leave you exposed for claims from the builder, the design professional or both. 

There is nothing really novel about this scenario, all building projects require that the owner make timely decisions and understand the potential for cost impact.  What is amplifying the risk is the number of seriously underbid contracts.  I consistently see projects awarded for bid prices that I know are 7-10% below cost; this is a huge problem with serious ramifications.   

2% For Protection 

Owners should anticipate the cost of a competent Owner's Representative and  payment and performance bonds to get these projects to the finish line.   The sooner the better for getting a professional consultant on board, an Owner’s Representative that is put in place during pre-construction can institute specific procedures to limit the potential for claims.  They can help pre-qualify the contractors and the sub-contractors that may be on the project. 

A bond from a good contractor will cost approximately 1% of the construction value.  An Owner’s Representative who will attend meetings, review schedules and applications for payment will cost another 1%. That’s a lot of protection and proactive control for 2%  

For projects that require a higher level of control, the Owner’s Representative can provide a full time Clerk of the Works.  Their job is to document the progress with photographs, take head counts on craft labor and monitor the production rates of field installations.  This is powerful and essential information when a project has design, cost and/or schedule issues.  Without daily logs and reports from someone directly on your team, the timeline and opinions of all other parties have an opportunity to become the job history. 

Overbilling is another serious issue, especially when a project may be underbid by a significant percentage.  Many lump sum projects are substantially front end loaded, it’s not uncommon for a General Contractor to be 20% overbilled half way through a project. If the contractor walks away or goes out of business, an owner could be left with a deficit from the overbilling, in addition to the additional cost it will take to get another contractor to complete the project. It’s critical to have someone on your team that can validate the schedule of values used for billing and insure that payments are being made to the subcontractors. 

The efforts undertaken by some General Contractors to find profit in underbid work is high risk for owners and their interests. I’m familiar with a project where the General Contractor made an award to a concrete subcontractor that was significantly underbid.  The sub-contractor had not intended on self performing the work, but instead re-contracted the work to another contractor he found on Craig’s List.   

On another project that I am familiar with the General Contractor subcontracted carpentry work to an out of town subcontractor, 600 miles out of town.  This sub-contractor parsed the scope of work in their contract and re-contracted to two other contractors.  The results were less than favorable, the project appears to be months behind schedule. 

The cost of construction is selling at a 25% discount, a payment and performance bond along with an Owner’s Representative to help professionally manage the project can be as little a 2%, total.  That’s still a 23% discount, and a recipe for a project that stands a much greater chance of getting done without serious problems. 

Copyright 2009 by William Graves, all rights reserved,  MBFblueprint.com