Construction is a complex process that often encounters unexpected situations impacting the cost of work. From material shortages to unexpected site conditions or even surprise requests from the local jurisdiction, a variety of factors can lead to unanticipated costs.
Risk in Construction
Construction projects inherently involve a multitude of risks. These include, but are not limited to:
There might be flaws or omissions in the architectural or engineering design, leading to issues during construction.
These include potential problems related to the actual building process, such as delays, construction errors, or safety incidents.
Fluctuations in the cost of materials or labor, funding issues, or budget overruns can create financial challenges.
Unforeseen soil conditions, weather events, or encounters with hazardous materials can impact the project.
Changes in building codes, zoning laws, or regulatory requirements can affect both the construction process and the project’s ultimate viability.
In property development, changes in the real estate market, from shifting demographics to fluctuating property values, can impact the project’s profitability.
Given these risks, allowances and contingencies serve as important buffers that ensure financial resources are available to address unexpected situations or costs. Understanding these two concepts is crucial for any owner to effectively manage their project’s finances and reduce risk.
Understanding Allowances in Construction Projects
The construction allowance, often referred to simply as an “allowance,” is a specified amount set aside in the contract to cover the cost of certain items that have not been finalized or selected at the time of contract signing.
Allowances provide a means to manage financial and market risks. They ensure that there is budgeted funding available for aspects of the project that have not been finalized at the time the contract is signed, such as specific material or equipment selections. This gives owners flexibility in their decision-making and the capacity to adapt to market conditions, like fluctuations in the cost or availability of certain items.
Common items covered by allowances might include:
- Interior or exterior finishes
- Certain types of equipment
The allowance gives the owner flexibility to make decisions about these items later in the process.
However, it’s essential to remember that if the actual cost exceeds the allowance, the owner must cover the difference through a change order. Conversely, if the actual cost is less than the allowance, the owner could save money or choose to reallocate the leftover funds to other areas of the project.
Understanding Contingencies in Construction Projects
Unlike allowances, which cover specific items, contingencies are funds set aside to cover unforeseen items during the construction process. These could include unexpected site conditions, design errors or omissions, or unforeseen changes in market conditions, like a sudden increase in material costs.
There are two primary types of contingencies: owner’s contingency and contractor’s contingency.
Covers items outside the contractor’s control, like changes the owner decides to make during construction.
Covers unexpected costs within the contractor’s scope of work.
Best Practices for Owners to Manage Allowances and Contingencies
While it is impossible to foresee every potential issue or change in a construction project, allowances and contingencies provide the financial flexibility necessary to manage the unpredictable nature of the construction process. They serve as essential tools for owners and contractors alike to ensure a project can adapt to changes and risks, ultimately helping to keep the project on time and within budget. The following strategies can be utilized to ensure either option is used properly:
Define and Document Allowances and Contingencies
The first step in effectively managing allowances and contingencies is to clearly define them in the construction contract. Each allowance and contingency should be itemized separately, with a clear description of what it covers. Ideally, these have been discussed during the preconstruction process, preventing any surprises at contract.
Review the Allowance and Contingency Amounts
As an owner, ensure the set allowances and contingencies are reasonable. If they’re too low, you may be faced with significant extra costs during the project. It can be helpful to discuss what amount is reasonable with the design team to ensure the amounts seem standard for the market and/or adequate for the risk associated with your project.
Monitor the Use of Allowances and Contingencies
Regularly track the use of these funds throughout the project. Reputable contractors should provide a running tally of allowance and contingency expenditures. It can be expected that these are reviewed at regular intervals over the course of the project.
Communicate Regularly with the Contractor
Maintaining open lines of communication with the contractor is vital. Discuss allowance and contingency spending at regular meetings to keep everyone on the same page.
Hire a Construction Manager or Consultant
If you are not familiar with construction management, consider hiring a professional to assist. A construction manager or consultant can help manage allowances and contingencies and ensure they’re used correctly.
Allowances and contingencies are not just financial provisions; they are also tools for managing the dynamic nature of construction projects. By understanding these concepts and adopting the best practices, owners can ensure the financial stability of their projects, maintain transparency with their contractors, and navigate the winding road of construction with fewer bumps along the way. By mitigating unpredictability and promoting adaptability, allowances and contingencies are truly the unsung heroes of successful construction projects.
If you need a second opinion or expert advice on your construction project, get in touch with us