In my earlier post Contingency – your best friend, I wrote generally about contingency especially for the early budget. Now I want to get into specifics.
There many areas of contingency which represent different levels of risk and arise at different stages of a project. By addressing each separately, you maintain better budget control and are better able to explain cost changes.
Two points before I get into the details.
Once you’ve carefully populated all the categories of contingency, at each budget update you will have to updating them. When you are faced with rising costs, it will be very tempting to erase the cost increases by reducing contingency before the risk has gone away. This only pushes the problem down the road. Bad news is always best faced early while you have more opportunities to deal with it.
Also, there is no reason why you can’t establish your own confidential contingency by understating the target budget that you give to your team. It’s there if you need it and if it isn’t necessary, there should always be some additional work that can be included in the project even near the end or after completion. See: Under Promise/Over Deliver – Expectation Management
The following describes these area of risk.
When considering the categories below, it may be useful to review my post Comprehensive List of Budget Items.
Entitlement risk
The planning and entitlement process carries a high level of risk, both in potential costs imposed and in limits on what or how much you can build. This process can drag on for many more months than anticipated and there can be an even greater cost from extended schedule than from actual cost increases. However, as the entitlement process is completed, this particular contingency may go to zero.
Expanding project scope
As the project progresses through the design phase, the scope of the project evolves, sometimes substantially. The needs and the goals of the project always evolve. In addition, unavoidable scope arises including the common ones of code requirements, site infrastructure and deferred maintenance. At the beginning of construction, this contingency should be eliminated.
I often include a general contingency for scope evolution, as well as specific contingencies for things like utility upgrades which often arise but have not been considered. The design team, trying to accommodate all their clients’ needs, sometimes push back at this limitation of their available funds. All I can say is, “prove me wrong”, which accelerates the investigation.
Low construction cost estimates
Every estimator misses something or doesn’t appreciate the complexity of some part of the project. As design and construction documents approach completion, the risk of inadequate estimates and the associated contingency is reduced.
Early in the project, before you have engaged a contractor, you will have an estimator who will carry an estimating contingency. Once a contractor is engaged, they will take on that responsibility which will evolve into the contractor’s construction contingency during construction. See below.
Scope added by Owner
You will change your mind. You will add things to the project, even after the start of construction. It is your right and it will make the project better. It’s important to acknowledge this. A budget increase due to an owner’s change is different that one for errors in documents. I often make a specific allowance for owner generated changes, so they can see the available funds.
Soft Cost risk
About 75% of these costs occur before the start of construction, then that contingency goes to zero. I carry the contingency for the construction phase separately. Every project is different and construction and even post construction soft cost risks can remain through project completion.
Owner direct hard costs
These costs are not included in construction cost and are not in the control of the contractor. It’s up to the owner’s team to estimate and contract for this work. This work typically doesn’t occur until near the end or even after the completion of construction so contingency should be reserved until that time.
Construction phase contingency
This contingency is established just for this phase. Here is a list of some of the things encountered during construction.
- Allowances for conditions not completely understood at start of construction
- Contingency for plan check comments not received at bid date
- Change orders for architect errors & omissions
- Change orders for unanticipated conditions, usually underground soils and utility issues and issues with existing buildings
- Change orders for owner initiated changes
- Weather issues
- Labor unrest
- Unanticipated building official requirements
Contingency Tracking
The state of your contingency is the most important indicator of the budget status and should be a part of each periodic budget update. For example, during construction, most lenders require a strict accounting of contingency use, tracking the specific changes in the budget to which contingency dollars are allocated.
Yet another contingency – Contractor’s construction phase contingency
The contractor has their own contingency which is in addition to the owner’s construction phase contingency. It’s the contingency that the contractor holds for their own use to account for problems with their estimate and bids. The contractor isn’t responsible for changes by the owner, errors or ommisions on drawings or unforseeable field conditions. They are, however responsible their bid and for escalation that occurs after the start of construction
So far we’ve been addressing the risks that relate to the scope of the work and the reliability of cost estimating.. Escalation and market factor risk is another matter.
Follow the link to Tick Tick Tick – Escalation