Construction Costs Have Soared
OSB is now running a minimum of $100 a sheet. Studs are $10 each. Metal is responding with similar gains for framing and piping. All systems of both residential and commercial construction are going skyward with no relief in sight. Appraisals are not in line with cost to build. There is zero price stability and zero ways to give an accurate completion date on a project. Now, let’s not get bogged down in the causes – the problem is here, and we have to deal with it head on.
You are in a Contract and are Being asked to Perform Regardless of Materials Pricing
Chances are, your contract requires you to perform based upon your bid regardless of materials cost increases. Your owner, developer or GC may legally insist that you perform based upon the contract. Those who are wiser understand the current state of supplies makes performance by subcontractors impossible in most cases. The benefit is that misery loves company – everyone up the chain is experiencing problems. So, it will take a project-wide solution to accomplish the goal.
We are seeing contracts for certain trades going almost $2 Million over budget! Work is being performed, you are submitting the increased costs to your owner or GC, and no payments are forthcoming. Rest assured, the problem is being faced up the entire construction chain from lender, to owner, to GC, to subcontractor and to materials suppliers. What do you do?
- REVIEW YOUR CONTRACT
The first thing you do is to review your contract – either you do it, or better yet, have your lawyer review it. You want to determine if there are any provisions which may deal with unknown price increases, force majeure provisions (we call these Acts of God – out of your control), and time is of the essence provisions. The fact of the matter is that you will likely be held to the terms of performance. However, since this is an industry-wide problem, the risk faced by owners and GCs is work-stoppage and incomplete projects. There will be no-one that they can likely hire to “take over” your scope of the contract because not only is labor scarce but contractors are running months before they can get to the next project because of their own delays and even if they could get to your project, their prices are not going to be any cheaper.
Your contract likely has terms not in your favor regardless of where you are on the chain. If you are a contractor, you and your lawyer must review any construction lending agreements to determine rights to be paid. The problem faced is that funds cannot be depleted to pay contractors running overbudget due to cost increases whereby remaining funds will be insufficient to pay remaining contractors.
For owners, this will all mean, if the project is completed, much higher pricing for end-product to make up the shortfalls. Depending upon your jurisdiction, you may or may not be able to pre-sell or pre-lease prior to finishing construction. Whether deposits, if allowed, will be sufficient to cover these increased costs is very risky. The better approach is to consult with the lender to see if additional funds are possible to be lent on the project.
- MEET WITH THE PARTY YOU CONTRACTED WITH
The best thing you can do is to get in front of the party on the other side of your contract. They will already be aware of the situation and are trying to figure out what to do at this point. THE WORST THING YOU CAN DO IS AVOID THE PROBLEM AND WAIT. If you keep on working and submitting overbudget costs (hoping they will have to pay it since the work was performed), there is a high likelihood you will not get paid or very slow pay. Don’t fall for the “we will work it out” later in the project line. The only person who will have to work it out is you.
While you can suggest a completely new contract for the same project, this is unlikely to be successful. The entire building chain will need cooperation from all parties. That means you, regardless of your position in the building chain, will need to give ammunition to the person above you – subcontractor helps developer, developer helps owner and owner can hopefully work with the lender. If the chain works as a team, trying to get the project completed on time and everyone get paid, a solution is possible, but cooperation is the key. Consider the following suggestions:
- Subcontractors – Look for an amendment to your present contracts with revised bids/costing to get the project on critical path. Go to your developer/GC/owner with something in your hand – don’t just go to them thinking they will have the solution. Be PROACTIVE. This will require you to come to the table, explain your end of cost increases and provide the solution or realistic numbers for you to complete the scope of work.
- Developers/GC – Immediately evaluate time and budget constraints. Take all trades and demand they give you new, realistic numbers to complete their scopes. Do not enter into any new contracts until the entire project revised-package deal is brought to the owner and approved. Only then should you begin firming up with your subcontractors. Keep in mind, there may be new requirements/contracts you will need to enter into with the owner’s lenders for assurances on getting the project completed if additional funds are provided. Also keep in mind that you have to move FAST. Material prices are changing literally weekly. A bid you get one week might not be good in two more weeks if you don’t finalize a revised contract and try and get some of the material costs locked in.
- Owners – Get with your lenders immediately and indicate you need additional funding. You will likely need new appraisals, revised contract language for the entire totem pole of trades. You may wish to consult with them by bringing your developer/GC. Appearance that you are serious about not losing them money helps a great deal. Consider time-delayed repayments, i.e., until so many units are sold, leased, etc. Think outside the box. One of the things the lenders will be looking at right now are time delays + increased costs. If you can perhaps solve part of the delay concerns, you might be able to overcome the increased costs hurdle.If you are a subcontractor assuming a contract for another which left the project, bear in mind you are likely going to face some very big uphill battles. There are not a lot of contractors out there who will be willing to insert itself into a project that is overbudget, the prior subcontractors were not paid, potential liens are hanging in the balance (holding up retainage that they ultimately will be a part in), etc. You may, however, find this to be a goldmine of business for your company. Keep in mind, you should have a lawyer review the contract before you enter into it. If the contract has not been changed in consideration of our current times, consider steering clear – you may be just setting yourself up for a lawsuit down the road. Things you can do immediately is to request to see a copy of the prior contract format and compare it to the one you were given. Next, talk with your lawyer about contract language that protects you such as assurances on payment, further increased costs, modifications to “time is of the essence” provisions, interruption of material supplies, labor or work stoppages, etc. The goal is to protect yourself and do a good and workmanlike job on schedule. Better yet, call some of the contractors that have not been paid to see what their experience has been. It might completely make up your mind whether or not you want to even think about that project.
New Builds are Ongoing – What to Look for in New Contracts
Now you have your existing contracts under control. What do you do about new projects? Chances are, you may see much more strict contracts. You will be looking for similar changes as mentioned above in the paragraph about assuming an in-process project. However, DO NOT GO IT ALONE. You need to have your lawyer review these contracts. A contractor cannot successfully operate in these times by merely signing the same old contracts. You can go broke and subject yourself to lawsuits. The situation we are in currently with construction is going to take some very skilled drafting and even, to some extent, finagling to look for ways to protect you and your company in these uncertain times.
We are working to evaluate acceptable provisions which protect each and every participant in construction. This situation is not likely to end soon, so contracting and cooperation are going to be the guides. There will need to be variances in contracts which contemplate these changes. Bear in mind, there will be some who insist on enforcing the current contracts. If you feel like it is impossible to perform under a new or existing contract, give us a call to take a look at it. As we like to say in our business, you can pay me now (a lot less) or pay me later (a lot more).
I hope this gives you a starting point for evaluating where you are right now in your projects and with taking on new builds. If you have any questions, please feel free to contact us. We can at least give you perhaps a different perspective than your own.