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November 13, 2019

Keeping Project Costs in Check

There’s no getting around it; construction costs have been trending up – more than 5% in 2018 and higher in some markets – due in large part to increases in both labor and material costs. As this trend has far from leveled off in 2019, managing project costs to maximize revenue can be a herculean task. If you keep in mind the key areas where trouble can arise and develop a strong working relationship between project owner and contractor, avoiding problems and keeping costs in check is possible.

Contract Language

The biggest risk to project cost 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.

Labor Cost & Rates

Rising labor cost is largely a result of a nationwide labor shortage. One way to combat this is to have a long-term network of subcontractors who are less likely to be negatively impacted by a local or regional skilled labor shortage. At the contract level, detail the reimbursable labor rate costs associated with the contractor and subcontractors. Before breaking ground, it is important to review each of these labor rates to make sure they align with the provisions included in the 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, reducing the likelihood of future disagreements and project delays. As the industry continues to face labor shortages and increased prices, agreeing to terms prior to breaking ground can keep costs in check.

Materials Costs

The cost of materials has increased in recent years due to tariffs, energy prices and resource scarcity. To avoid sudden price increases, owners and contractors often work together to find alternatives and keep up to date on changing costs. Contractors are sourcing materials on a regular basis and have a deep understanding of how to keep costs down. Other strategies, when possible, include pre-purchasing materials to hedge against scarcity and price inflation and implementing economies of scale.

Change Orders

Any major construction project comes with 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. This can translate to substantial overcharge. In one example we are aware of, 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 & Bond Costs

Today, many large contractors use complex self-insured insurance and bonding programs. Project owners 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 multimillion-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.

Trust Your Contractor

Collaborating with your general contractor as a trusted advisor rather than a commodity is another way to keep costs in line, especially when it comes to material and labor costs. Consistent communication between an owner and contractor can help to cut down on labor and materials costs. Developing a close relationship with a contractor can also lead to long-term relationships and trust, which often translate into project savings.

Your Team

Collaborating with contractors and executing clear contracts that consider pricing of labor rates, changes in the work and insurance costs can help you stay within budget. For additional information on construction cost management, don’t hesitate to contact Mark McCarthy (mmccarthy@cbiz.com or 617.761.0627) or your local CBIZ advisor.

2019 Individual Tax Planning Supplement

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