Be Very Cautious & Use Your Architect!

by Geoffrey Butler, AIA

We have all become aware that with the downturn in the economy, the cost of construction is going down. In some instances we have seen 30 percent drops in the cost of projects. The reasons behind the drop are many fold. There are less projects out there which provides for a more competitive bidding environment. The availability of materials is much better as suppliers work to reduce their inventories and maintain market share. Subcontractors in a more competitive environment work very hard to find ways to be more competitive. This can mean they lower their expected profit margin, trim their overhead costs, find ways to work smarter and be more efficient. However, we have also found that sometimes they just charge whatever it takes to get the job, whether they think they can get it done for that or not.

Here are our observations and predictions as this economic slump continues:

Materials costs will stay low until the inventory levels reach the bottom. The materials manufacturers are going to continue their efforts to maintain profitability. They will be shutting down inefficient plants (laying off people), and they will be trimming their operations, including their distribution systems and sales force. Less material will be sitting in warehouses waiting to be shipped. With no inventory and reduced production capabilities, as we come out of this slump we’ll find longer delays and escalating prices simply due to the laws of supply and demand. We do not know how long we can enjoy (or take advantage of) this down cycle in material prices but trust me, it will end.

Labor costs are going to stay low as companies work to eliminate and “weed out” in their organizations. These are the guys that you always see leaning on the shovel smoking a cigarette. They are late to work, first to take a smoke break, last to come back from lunch, and are generally sloppy, unreliable and uncooperative. Then, the companies will reorganize their workforces to be more efficient and will rely on their really good workers. They will bid projects tighter assuming better efficiencies and having their managers actually do more work. This will be a good thing for a while.

The companies themselves will be evaluating their operations and trying to trim their own overhead costs including the owner’s expectations on return on investment. General Contractors who begin to “self perform” more work will tend to be more stable and realistic about the costs to build a project. They will have their core group of workers who they can count on. They know what they can do and what that costs. Rather than subcontract everything and basically broker the job, they will revert back to earlier times when a Contractor actually built the project rather than manage a process. The companies who can manage their operations in this fashion will be the ones we want to count on going forward.

The reason I suggest that self performing the work is a good thing is that we will find subcontractors going out of business more often.

  • They will be bidding work for less than it really costs to do the work.
  • They will be paying themselves first and delaying payments to suppliers (thinking they can pay them later).
  • They will be paying for the last project from the next project and finally they will collapse.

If that happens in the middle of your project, there will be mechanics liens and ultimately, if your general contractor is not financially strong and he goes under too, you will be paying twice for work on your project. That really low price will not be low anymore.

The risks involved in accepting an extremely low bid can be managed in several ways. The easiest thing we can do is to require a Payment and Performance Bond from the General Contractor. This is basically an insurance policy which has a surety guarantee that the contract payments are properly applied. There are caveats to that as this policy has a decreasing limit of liability for the surety and if you over pay the GC and the balance on the contract is less than the cost to pay off all the liens and complete the work, you end up making that shortfall up. This requires that your architect be very careful in approving any payments to the GC so that they do not get paid more than the value of the work completed to date less a retention.

However, many small contractors can’t provide a Payment and Performance Bond. Yet, they are offering a tantalizingly low bid. What do you do then? Your architect can work with the GC to verify their financial condition. They can submit financial statements for review. The Architect can call around and verify the GCs payment history to companies they would likely need to use on any project. Examples are concrete companies, lumber yards, etc. We can’t verify everything, and we cannot be assured that while they have been good in the past they won’t run into financial problems in the coming year when your project is being built.

The payment process can also be developed which insulates the Owner from misuse of funds. We can require lien releases from all subs and suppliers on site. We can use a title company to issue payments to the GC and those subs using joint checks. We can require that the subcontractors provide lien releases from their suppliers and subs. With careful management of this process, you can protect your interests.

All of this is not a simple process. It will cost you more to take these measures to protect your interests. Payment and Performance Bonds cost between 0.5 percent and 2 percent depending upon the strength of the contractor. That alone is an indication of the viability of your GC. If you have two GCs within a few thousand dollars of each other on bid, look at the cost of their Performance bonds. The lowest cost bond in usually the GC with the least debt, and the better history of performance and more likely to still be in business when you are finishing up your project.

If there is no Performance Bond available, then you need to ask your Architect to take these extra measures for you to develop a program in conjunction with your lender. The money you spend for a Bond or to have your Architect manage this process will pay off in the long run and the risk you assume will be correspondingly reduced.

No one knows how long we can enjoy the lower costs for construction even if we can manage the risks. It is likely that we will find after a long period of downturn that we will lose a lot of bad and some very good contractors and suppliers as they leave the market. We will find that costs will begin to escalate rapidly when the economy comes back as more projects hit the streets and find fewer contractors to do the work and longer lead times on materials.

This economic downturn is changing the business landscape as it relates to design and construction even as it changes they way everyone does business. What we all have to do is to be very smart in how we react to it.