Four Major Risks Construction Owners Face (article)
In a world of constant expansion and development, construction is inevitable, and values recorded by the Census Bureau indicate that it is currently booming. In 2016 alone, cumulative U.S. construction project spends reached $1.1 trillion, the highest recorded amount since 2006. With increased construction spends comes increased risk. Knowing the four major risk areas you face as a construction owner can help you manage your upcoming projects and prevent overpaying.
The biggest risk to an owner lies in the contract itself. Too often construction contracts are muddied with unclear language that makes it difficult to determine reimbursable project costs. For example, if a contract’s intent is not clearly stated, a project owner might assume the project is cost-reimbursable, while a contractor assumes the contract is lump sum. In the case of one academic institution, this lack of contract clarity resulted in a $2 million discrepancy in addition to costly legal expenses. Draft your contracts using clear, transparent language so that every party knows exactly which costs will be reimbursed. One way to avoid confusion is to write clauses and provisions so that even someone unfamiliar with the project could easily understand the reimbursable costs.
Every contract should detail the reimbursable labor rate costs associated with your contractor and subcontractors. Before you break ground, it is important to review each of these labor rates to make sure they align with the provisions included in your initial contract. When labor rates are reviewed and approved up front, all parties are aware of the rates that will be billed on the project which reduces the likelihood of future disagreements. This strategy saved one company nearly $600,000 because they determined upfront their subcontractor labor rates were too high when compared against industry averages and local union agreements.
With any major construction project comes surprises that can increase the scope of work. If additional work requires you to deviate from your original plan, a change order will be needed. It is important to carefully review every change order to understand why the change is necessary and confirm that the pricing is fair to both the contractor and project owner. For example, a change order might include certain line items more than once or list labor rates at a few dollars higher than industry average. For one academic institution, labor rates that were $6 higher than average when multiplied by thousands of hours of work resulted in over $500,000 in overstated charges.
Insurance and Bond Costs
Today, many large contractors use complex self-insured insurance and bonding programs. As a project owner you should fully understand the costs and potential risks related to these programs. For example, if a performance and payment bond rate is inflated by 0.1% on a multi-million dollar project, the identified credit could result in thousands. Ensure you are only paying for insurance coverage and limits you have specified in your contract. Carefully review your insurance coverage and costs to guarantee adequate coverage while also mitigating the risk of over-billings.
Bottom Line – Knowledge Is Peace of Mind
Understanding the major risk areas you face prior to beginning your next construction project will help you manage risk from inception to completion. At a minimum, you need to execute clear contracts that consider pricing of labor rates, changes in the work and insurance costs to help you stay within budget.
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