What's new for 2016

Happy New Year everybody!

Yes, I know I'm a little late, but better late than never.

Im going to start 2016 in a slightly different way.

If you were with me from the start (launched my website in March 2015) you will note that the content and design of my site has evolved quite a bit.

From the start, I wanted my site to be a place where you could find articles full of in depth content to help you manage your projects more effectively.

I feel pretty good about the current state of the content and the design of the website so I want to shift my focus to shorter more frequent blog entries. 

My hope is that this shift will allow for more of a quick read along with more interactions between you and I.

I will still be producing articles (like the ones I published in 2015) but there will be fewer of them. 

I would love your feedback on this approach. 

Do you prefer long articles with lots of content or blogs that offer a quick snapshot on a single topic?

Where do contractors hide profit?

Where do contractors hide profit?
By Luis Gile
December 2015

The title of this article suggest that's all contractors are out to hide profits, but I want to make sure that you don't take away that impression because it's simply not true.   The majority of contractors are honest and hard working.  They are running a business and every business is entitled to make a profit.   Unfortunately, there are instances where a contractors "double dips" (charges profit on top of profit) or deliberately hides profit in their invoicing.  In some cases these infractions, are the result of common but incorrect business practices.  Other times it may be intentional.  Either way, my goal for this article is to identify for you some of the potential pitfalls and call your attention to the places where this is most likely to occur.  

Number One:  General Conditions

The General Conditions of Construction is one of the most common places for double dips to happen.  This is also the place where additional charges are improperly applied when a construction change order is necessary.  The key to avoiding this is to make sure that you completely understand and have defined what general conditions include.  This MUST be done up front.  Before you even request the bids.  In other words, you need to tell the contractor what you expect the general conditions costs to include.  This will ensure that when you receive all of your bids (hopefully you have solicited at least 4), each of the bidders have quoted their price in the same way.

Number Two:  Self Performed Work

Self performed work refers to any trade or construction work that the General Contractor performs with his own workforce (as opposed to sub-contracting the work to another company).  In residential construction many of the companies that operate as general contractors began their businesses as trade contractors.  Some may have been carpenters, plumbers, or even electricians, but as they grew and started to get more and more work they evolved into a General Contractor.  This is good because it is a sign that they are very capable and if you understand this, it could be an opportunity for cost savings.  Unfortunately, most homeowners don't know to ask and actually end up paying the general contractor twice as much profit for the portions of work that the GC self-performs.  Don't be afraid to ask about which portions of the work the GC will self-perform and make sure to ask what the profit margins are for both the GC portion of the work and the trade work.  Keep in mind that each trade contract will include profit that the trade contractor needs to make for his business.  If your GC is self performing a portion of the trade work himself, then you should be able to either negotiate a lower profit margin or no profit margin at all for the work he is self performing.

Number Three:  Rental Equipment

Construction Equipment such as bulldozers, backhoes, cranes, lifts, and dump-trucks are commonly used on construction projects.  Most of the time, sub-contractors will provide their own equipment and include the costs of the equipment in their price.  Other times, the GC might rent equipment from an equipment rental company, these costs are invariably passed along to the Owner as rental equipment costs.  Rental equipment costs could either be included as part of the cost of the work or as part of the general conditions.  In some cases, the GC might own his own construction equipment and he may charge the owner a rental fee for using that equipment for the project.  Construction equipment is expensive to own and maintain and contractors are entitled to charge fees to cover their costs.  However, the cost of maintaining equipment should not be the same as the cost for renting equipment.  Costs for GC owned equipment should be treated the same as self performed work.  Don't be afraid to ask who will be providing equipment for your project.  If the GC will be providing some of his own equipment, ask him to quote you his rates and make sure you understand how he will be applying profit to those rates.  

Number 4:  Change Orders

It may seem pretty obvious that change orders are a great place for profit to be hidden, but you may not know how profit is hidden in change orders and how to avoid overpaying for change orders.  The most common way that GC's overcharge on change orders, is to add general condition costs to every change order.  If you have properly defined what is included in the general conditions costs, then you should be able to discern when a change order should include general condition costs and when it should not.  To ensure that you are not overpaying for change orders, make sure you negotiate change order rates as part of your overall price negotiations.  Ask for change order rates as a percentage mark-up.  These rate can be applied to change orders by multiplying the costs of the change by the percentage markup to establish the GC's profit.  Also, if you know in advance that a certain portion of the scope is subject to change,  the best way to avoid overpaying for a change is to solicit alternate pricing.  Alternate pricing can be used to price alternative solutions for almost any part of the scope of work.  By soliciting this cost up front during the bid you are ensuring that you have competitive pricing for this alternative scope.

The various cost elements that make up the cost of a construction project can be very complex.  You have multiple contractors and lots of moving parts to track.  Being clear and deliberate about every cost element is the best way to ensure that you are getting a fair price.  Be fair to your General Contractor.  He should not be expected to eat costs or perform more work than you are not willing to pay for.  Keep in mind that he is running a business and he is entitled to earn a fair profit margin on everything he does for you.  Conversely, you are entitled to know and to negotiate just how much of a profit margin you are willing to pay.  Address all of these issues early on and you will have a much more successful project.  

How to develop a budget for your construction project (Part 2)

How to develop a budget for your construction project (Part 2)

by Luis Gile

Building on the basic information we discussed in Part 1, we can now move forward with developing our project budget.

First lets talk about the various estimating methods that we can use.

Estimating methods

There are several methods for estimating projects.  The estimating method you choose will be determined by how well your scope is defined.  It is perfectly acceptable to change your estimating method as your project advances.  In fact I highly recommend that you revise your estimate each time your scope changes or becomes better defined.

At the earliest phases of work, your scope definition is very limited so your estimate will be less detailed and you should have a greater margin of error and contingency.  As the scope gets further defined, estimates become more detailed and should have lower margin of error and lower contingency.

The types of estimating methods I will cover are:

1. Area Pricing 

2. Unit Pricing

3. Budgetary Quotations

4. Percent Cost of Work

Regardless of the type of estimating method you choose, all estimating methods require two pieces of information.  The first piece of information is the scope.  The second piece of information is the market rate.   

Area pricing

Area pricing uses the area of the space you want to build multiplied by a cost per area.  This pricing method can be used for either hard costs or soft costs, but it's most commonly used for hard costs.  We use area pricing when our scope of work is very limited.

The only scope information needed to use area pricing is the approximate area of the space you want to build.  In the United States the unit of measure we use for area measurements is square feet.  We can use the project program we discussed in Part 1 to estimate our area.

The market rate needed for area pricing is a cost per square foot.  The cost per square foot is affected by a number of factors including, the type of project, your geographic area, and the scale of the project.

Unit Pricing

Unit pricing can be used in a variety of ways.  Most often unit pricing is used when the scope of work is more detailed and well defined.  

Scope definition for unit pricing typically requires a detailed set of design drawings.  If you have detailed design drawings you can use the drawings to perform material take-offs.  The term "material take-off" is a method of estimating material quantities by taking scaled dimensions off of design drawings.  

Market rates used in unit pricing are typically specific rates for materials, equipment , and labor.  Unit pricing can be collected from a variety of sources including directly from suppliers and also from historical pricing.   

Budgetary Quotations

Soliciting budgetary quotations directly from trade contractors and material suppliers is another common method of cost estimating.  Soliciting budgetary quotations can be even more accurate than unit pricing but can take longer than other methods.  

The scope of work for this estimating method can vary greatly from very little scope definition to a very detailed set of design drawings.  The value and accuracy of budgetary quotations varies equally with the amount of scope definition.  It's also common to rely on the trade contractor to perform the take-offs for his specific trade.

You wont need any market rates for this estimating method because the budgetary quotes will come from each trade contractor.  All you need to do is add each contractor's price together.  When you use budgetary quotations it is important to ensure that there are no gaps in scope between trades contractors and that each contractor is clear about what scope they need to quote.

Percent Cost of Work

Percent Cost of Work rates use rule-of-thumb percentage rates to estimate soft costs.  

This estimating method is dependent on having an estimate of your hard costs.  You can use any combination of the previously discussed estimating methods to estimate your hard costs.

Once you have your hard costs estimated, you can apply the percentage rates to estimate your soft costs and then add the hard costs and soft costs together.

Hybrid pricing

It is common to use a hybrid or blend of these options.  How you combine these methods is entirely up to you.  

In this article we will focus on a hybrid approach that uses area pricing for hard costs and percent cost of work for soft costs.  This blend of pricing methods is the simplest and most effective way to budget a project at an early phase of development.

How to budget

If you have been following my blog you may recall the May 2015 entry entitled "What are the phases of work of any construction project".  In that article we took a step by step approach that began with high level scope definition and methodically made our way through design.  When planning and executing a project we always begin with design and we add layers of detail until we know what we want to build.  The construction work is always the last step.  For budgeting we actually start backwards.  

We will be using percentage of cost of work rates to estimate our soft costs, so we will need the Cost of Work as our multiplier for these rates.  Establishing the Cost of Work up front will also help us understand the scale of the work we are taking on. 

First we'll estimate the hard costs using your program's estimated square footage (established when you developed your program) and a cost per square foot market rate.  The math on this is pretty simple, simply take your estimated square footage multiplied by the area market rate

EXAMPLE:

From Part 1 we estimated the program to be 421 SF

Estimating your hard costs

To estimate your hard costs, we will need a cost per square foot market rate.  

All area pricing rates will be based on historical rates.  These rates are highly influenced by the location, date, and scope of the project that the rate is based on.  in other words, if you use a rate from a garage addition in New York from 5 years ago and your project is a kitchen addition in Kentucky that you expect to start one year from now, you wont have an accurate budget.  Try to find rates that are as closely matched to your specific circumstances as possible.

I recommend getting at least three area market rates and averaging the three together.  This eliminates any guess work and gives you the best chance at using an accurate figure.

Here are a few sources that I recommend.  You can type in "cost per square foot" into your web browser and I'm certain you will find others.

http://www.building-cost.net/CornersType.asp

http://www.home-cost.com/construction-cost-per-sf.html

For this example, we will use an area market rate of $200 per square foot.  Now we multiply the square footage by the area market rate as follows:

421X 200 = $84,200

Therefore our hard costs for this project are $84,200 eighty-four thousand two hundred dollars.  This is the cost of the labor, materials, and equipment needed for the project.

Estimating soft costs

 For the soft costs of this example we will focus on estimating Architectural fees, contractor fees, and general conditions costs.  These costs are the most common soft costs applicable to most projects.  

We will use percent cost of work rates to estimate these costs.  These rates are typically within the following ranges.  The specific rate you use is dependent on the location and scale of your project.

1. Architectural fees, (6% to 15%)

2. Contractor fees, (5% to 15%)

3. General conditions costs,  (10% to 20%)

If we use the $84,200 estimate for our hard costs we can estimate the following:

Architectural Fees (15%) = $12,630

Contractor Fees (15%) = $12,630

General Conditions Costs (10%) = $8420

Sum up your costs then add contingency and margin of error

          We now add up all your costs and add our contingency and margin of error

          Hard Costs...................................$84,200

          Architectural Fees........................$12,630

          Construction Management Fees....$12,630

          General Conditions Costs...............$8,420

          

          Subtotal....................................$112,000

          Owner's Contingency (@15%) .....$16,800

          Margin or error (@20%) .............$22,400

          Total Budget.............................$151,200

Keep in mind that the "Owner's Contingency" and the "Margin of Error" are essentially funds that you need as safety nets.  These costs are not to be shared.  You and maybe your Project Manager (if you have one) should be the only people who know you have this money set aside.

Never reveal your budget to your Contractor and when you speak with an Architect about your project, reveal only your estimate for the hard costs.  When an Architect asks for your budget, what they want to know is whether you are looking for higher end finishes or a basic design, so giving them your estimated cost for hard costs should suffice.

Now you should have enough information to develop your budget.  Let me know how well the process works for you and when your project is completed, email me back to tell me how close your numbers were.

How to develop a budget for your construction project (Part 1)

How to develop a budget for your construction project (Part 1)
By Luis Gile

Developing a project budget is one of the most important early steps of any construction project. This will be a multi-part series that will give you the background and information you need to develop a budget for your project.

Taking the time to develop an accurate budget is an essential step prior to contracting an Architect or a General Contractor. This will ensure that you have the capital to complete your project and that you don't commit yourself to any contracts without knowing your spending limit.

Before you begin building your project budget, there are specific pieces of information that you need and some concepts you should understand. In this first article we will go over the basics so that you can have good foundation for starting your budget.

Project Program

Before we begin budgeting, we have to estimate how much space we need. We can do this by by developing a project program. Your project's program is a list of spaces with critical design information such as square footage, adjacencies, and other specific requirements. I will publish a more detailed article about how to develop a program in a future blog.

For now, to simply estimate your square footage, note down all of the spaces you want with an approximate width and length of each room. Multiply the width and length for each room to come up with the square footage for that space. Add up all of the square footages for all of the spaces you need to determine the total footprint of your new space.

The best way to estimate the size of a room is to consider the furniture you will be needing in each space and then adding an appropriate amount of space for circulation. For example a dining room should be large enough to accommodate a dining table, chairs, and at least one hutch or credenza. The clear space around the table should be no less than 4 feet, but if you want a more comfortable space, you may choose to add 5 feet or more. You may also want to add an additional 10% to 15% more square footage to the total to allow for structure and connecting space between multiple rooms.

Here is a sample list for reference:
Galley Kitchen........10 feet wide 15 feet long......150 square feet
Dining area............12 feet wide 18 feet long......216 square feet

TOTAL SQUARE FOOTAGE................................366 square feet
Circulation 15% of total.................................... 55 square feet

Total program..................................................421 square feet

Adjust the room names a sizes to suit your project. Once you are armed with this information, we can move on to the next concept.

Margin of Error

Margin of error refers to how much higher or lower your actual project costs will be from your budget. Margin of error is meant to account for fluctuations in cost and or square area. During early stages of a project it is common to assume that any cost estimate will have a 20% to 25% margin of error. To account for this margin of error, your budget should include a line item specifically called "Margin of Error".

As you get closer to the start of construction, your margin of error can be reduced. Keep in mind that an estimate is always just an estimate. There is no such thing as a 0% margin of error on an estimate, so no matter how accurate you think you are, always carry a margin of error in your estimate.

Contingency

Contingency is a word used to add monies to a project to cover the cost of unknowns. Contingency is different than margin of error in that contingency is meant to capture things your budget missed. 

The word contingency may be used by contractors, estimators, or even architects. The use of the word has different implications depending on who is using it. I mention this only to convey that when we talk about contingency for your budget, we are talking about the "Owner's Contingency". Owner Contingency is meant to cover hidden conditions of the site or other unknown costs of the project. This is not a fund for making changes to the scope. This is your safety net for completing the work.

As the Owner, you have a responsibility to pay for the services, labor, materials, and equipment needed to complete the work. Failure to make payment to any service provider places you and your property at great financial risk. As such, you have an obligation to ensure that you have sufficient financing to cover all costs. You don't want to find yourself 3/4 of the way through construction only to realize you have run out of money. Make sure you carry 15% to 20% of Owner's contingency throughout the project. This is over and above any margin of error.

Also, please make sure that your contingency is fully funded. This means that you either have the capital or sufficient financing to cover the contingency. It's not enough to include the line item on your budget, you must also have the funds set aside and ready to use if needed.

Cost components
Your project budget will include a combination of estimates to cover hard and soft costs.

Hard costs refer to the cost of construction.
Hard costs include the following:
1. Trade labor such as masons, carpenters, plumbers, etc.
2. Material costs such as concrete, wood, light fixtures, etc.
3. Permanent equipment such as boilers, air conditioners, water heaters, etc.
4. Temporary equipment such as cranes, scaffolding, etc.

Soft costs refer to all of the other costs of the project.
Soft costs include:
1. Architectural fees,
2. Contractor fees,
3. General conditions costs,
4. legal fees,
5. real estate fees,
6. cost of land acquisition,
7. permit fees,
8. zoning fees,
9. filing fees.

We will begin our estimate with the hard costs first and then use the hard costs as a basis for estimating the soft costs.

With these basic concepts in mind we have set the stage for developing your project budget.

In my next entry, I will go over the various estimating methods that we have at our disposal and then go over a few examples of how we can apply these methods. Please join me again next month where we will continue to explore how to develop your budget.