How to manage your costs and reap rewards

Cranes are again filling city skylines all over the United States, and that’s great news for the construction industry. The proverbial clouds have cleared, and it seems that there is nowhere to go but up. Now that the economy has bounced back, many people are eager to dust off their recently shelved projects and go full speed ahead.

That scenario works for many people — but cost consultants are a lot more cautious than most people. And for good reason. We believe that it’s essential to be fiscally responsible where construction is concerned — in fact, it’s even more critical in boom times than bad times. If you do the right planning at the outset, you will have many fewer regrets and much better results.

There are a couple of reasons to proceed cautiously. First and foremost, when construction activity increases, construction costs always rise. That’s because there is less available labor and greater need for that labor — it’s a simple matter of supply and demand. In addition, in the past ten years or so, new technologies have dramatically changed construction. So the industry has to adjust to, and then absorb, these new methods of design and delivery, as well as the cost implications that come with those shifts.

We also need to recognize that we’re still in rebound mode. While people have the confidence to start new projects (or restart projects, as the case may be), the economy is still compensating for the previous slowdown. In other words, we’re experiencing a recalibration in terms of what the economy can or cannot bear, but we’re not fully stabilized. And that’s contributing to current labor shortages, even while we’re on the upswing.

For example, let’s look at housing construction. The normal rate of housing construction should be between 1,250,000 and 1,500,000 new homes per year. During the housing boom that took place from 2000 to 2006, we were building an average of almost 1,800,0000 houses annually. Essentially, that’s an overbuild of at least 2,000,000 homes in four years (based on a need of 1,500,000 homes per year).

As we know, however, the economy moves in cycles. During the drop-off that occurred after 2006, the annual output in the United States fell to about 500,000-750,000 homes, which resulted in a gap of approximately 5,000,000 houses. Added together, over the last decade, we have accumulated an overall shortage of about 3,000,000 houses. To catch up, we now need to build as many houses per year as we did at the height of boom. This is having a direct impact on construction, causing it to drive up inflation in the near term. (Data source: United States Census Bureau and the Department of Housing and Urban Development).

A 360-degree view of construction

In view of this volatility, good decision-making requires having the right information from the get-go. The good news is that the Consumer Price Index (CPI) is pretty low. The CPI monitors inflation rates in the general economy, based on the prices of consumer goods and services. And while it’s good that this number is low, we want to make sure that it doesn’t dip too low, because then it will cause deflation.

While the CPI gives some important information, it’s not a very accurate picture of the economy at large, because it doesn’t account for some of the biggest consumer costs, such as energy and housing. And, in most cities, construction costs right now are rising at a far higher rate than costs for other goods and services.

It’s also important to get good information about the design and construction industry. Engineering News-Record’s Building Cost Index is a far better yardstick for the construction industry than the CPI, because it measures the change in cost of materials and labor. Since the cost of labor fluctuates most dramatically between economic upturns and downturns, it’s one of the most critical pieces of information to have when you’re planning a project.
Even so, these costs only tell part of the story; they don’t paint a full picture of the construction landscape. The definition of “construction costs” needs to be much broader, because costs are affected not only by the hard costs of construction and labor, but also by information about overhead levels, profit margins, and sales taxes. At Rider Levett Bucknall, we publish this information on a quarterly basis in our Comparative Cost Index. Most other indices don’t take these factors into account.

By looking at costs in this 360-degree way, we get more insight into the construction industry. We’ve found that, for example, construction costs typically increase more rapidly than the combined cost of labor and materials in a boom economy. If you think about it, it’s pretty obvious: in a boom cycle, labor costs go up, but so do profit margins. And the overall construction cost outlook is influenced by all of these gains — not just one or two of them. Similarly, in a bust cycle, construction costs go down or may even be reversed, due to reductions in overhead costs, as well as lower profit margins. When all the costs of construction are considered, the increases are much more dramatic than we might otherwise expect.

How are you measuring costs?

There’s more technology than ever before, especially in the construction industry. Buildings are more wired, green, and efficient than they’ve ever been. They’re also more sophisticated, safer, and more resistant to disasters like fire and earthquakes. These changes affect every market — from healthcare to hospitality, residential to education. Designers and builders are also using pre-fabrication to build more effectively and manage projects more efficiently.

Technology can also help experts in the construction industry to gather and evaluate information, which can lead to better financial planning. With 3D modeling, designers and construction managers have access to more information sooner than they ever had before. At the same time, the construction industry needs to understand this information and be able to interpret it accurately.

For example, the information embedded in a BIM model is not always useful, because standard costs are not applicable to all buildings. Yet the BIM model assumes standard, fixed costs that don’t change. So, while BIM is an extremely useful tool for people who design buildings, people who use BIM for cost estimating can fall into traps if they don’t understand the complexities of construction.

Consider a BIM model that has embedded cost information to estimate the “standard” cost of a glass curtainwall. That cost will vary widely, depending on whether a piece of that curtainwall is on the second floor of a two-story building or the 103rd floor of a high-rise. In addition, the data embedded in a model does not update as costs invariably change, due to the market and other factors affecting the industry. For BIM to be a more robust and useful tool in terms of estimating and predicting costs, the industry needs better ways of keeping information relevant and up to date.

Start off on the wrong foot and you’ll be limping by the end

The construction industry is getting more complex, so it’s more critical than ever to estimate and manage costs wisely. It’s also important to measure as many variables as possible and bake those metrics into the decision-making process. Every decision has an impact on cost — from the decision to use a construction manager to the decision to use a certain material or building system. All choices come with a price.

You’ll be most successful if you take the broad view. Sometimes it’s better to invest more money at the outset of a project in order to yield a better return over the long run. This is particularly true in the case of sustainable construction. When most owners weigh the impact of “going green,” they typically think about the capital costs of those decisions; generally, low-energy systems require a greater initial investment than a traditional system. However, if you consider the influence of sustainable systems over the entire lifespan of a building, they can actually have a positive influence on long-term ownership; more efficient building systems can lower energy use and reduce operating costs over time. So you can’t afford to be myopic.

Likewise, it is critical to assess building life before you build, and understand the owner’s goals in terms of longevity. These decisions have a direct impact on ROI. Of course, most people consider codes or best practices when they design, but they don’t always think about timespan. From a cost perspective, these decisions are crucial. Let’s go back to our previous example of the curtainwall. The choice of one building façade or curtainwall system over another can appear to be a subjective design decision, but it can also have a long-term impact on the lifespan of that same building, as well as the operational costs of that building. Where costs are concerned, every choice matters.

With recent changes in procurement methods, cost decisions will be even more critical than ever. Public-private partnerships (PPPs) are becoming increasingly common for delivering large projects. In addition to PPPs, government agencies will be relying more and more on private developers to build their new facilities. This type of procurement will require different and innovative funding mechanisms. As a result, the cost and financing of projects will get more complex over the next ten years, so the industry will have to become sharper and more sophisticated.

Unfortunately, if you don’t get it right at the start, the budget won’t add up in the end. That’s what I call “Anderson’s Maxim” which is this: Most projects that are launched with poorly conceived budgets never fully recover. On the other hand, if you start with a realistic budget, and avoid the usual pitfalls, you will be able to see a project through to its successful and profitable conclusion.

Julian Anderson is a member of Rider Levett Bucknall’s global board and chairman of its Central Consulting Services (CCS) group of companies. He is a founding shareholder and president of the company’s North American practice where he is responsible for overall management.