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How to better control direct construction costs

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ith rising materials costs and downward price pressures, it’s more important than ever to manage project expenditures. Since there are fewer jobs out there, it’s essential to make a profit on every project. Customers are also looking for efficiencies and are examining quotes closely. Stay one step ahead by managing your direct and indirect costs and their effect on gross margin, which must cover administrative overhead and profit. The gross margin – what’s left after job costs are subtracted from revenue – will vary according to the type of construction project. The percentage can range from under 10 percent on large commercial jobs to more than 40 percent for home remodeling. Managing to the correct gross margin is an effective way to remain solvent on a job-by-job basis and company-wide. With a solid understanding of your cost structure, you can make informed decisions about taking low-margin jobs for cash flow’s sake rather than just hoping for the best. To improve the future, first look at the past. Analyze the financial performance of projects over the ➜ Nonresidential construction: past year in regards to revenue, job Recent upswing expected costs and gross margin. Identify the to continue in 2013 most profitable as to size and type of project. Your present company ➜Pent-up demand signals resources are best suited to handle more apartment those profitably, so bear that in mind construction while seeking new opportunities. Next, review the jobs with gross margins below the appropriate threshold to see what went wrong. Was the problem in your estimating?

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Jan./Feb. 2013

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Or did other factors contribute, such as unexpected increases in material costs or overtime labor? Delays on the job cost money, too, because you aren’t drawing down revenue, but the overhead clock is still ticking. Maybe you had too many change orders without corresponding revenue. All of this is useful information as you bid and plan new jobs. There is a new emphasis on engineering and design today in regard to cost containment. With tight resources, customers are seeking the best prices but, of course, they want a good product. Avoiding overbuilding is key. For example, one small nonprofit was quoted a price for high-end offices when they were satisfied with basic walls and carpets. Help customers work through price-quality trade-offs to build what is appropriate and functional. If you are using outside design firms, consider incentives for staying within budget. Labor is one of the largest direct costs, and lack of performance will chew up profits. But however hard working the team is, paid slack time is inevitable as people wait for deliveries, travel between jobs or do company errands. In figuring out an employee’s true cost, include salary or wage, benefits and taxes to create a total weekly cost, then divide the total by See Controlling Construction Costs inside

An information bulletin to contractors from:

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Nonresidential Construction G

Recent upswing expected to continue in 2013

rowth in 2012 signals a revival of the nonresidential construction industry. Nationwide, the sector saw a 9.3 percent increase in revenues during the first half of 2012 compared to 2011, the U.S. Census reports. It was the first increase after three years of decline. June and July, the latest information available, saw some construction slowdown, but the overall trend for 2012 is expected to be positive. Looking ahead into 2013, an overall growth rate of 6.2 percent for the entire nonresidential construction sector is predicted by the American Institute of Architects (AIA), which prepares a consensus forecast drawn from data provided by seven industry associations and economic analysts. The AIA’s forecasts are conservative – they predict until 2015 will provide a boost. The EB-5 program awards that 2012’s final growth rate will be around 4 percent. permanent resident visas to foreign investors who provide Nationwide Vacancy Rates equity capital to U.S. companies, including real estate developers. The minimum investment is $500,000 in a high Quarter Office Industrial Retail unemployment area; $1 million in other locations. Each year, 4Q 2010 16.4 % 14.3 % 13.0 % 10,000 visas are awarded. Despite the recession and the growth of emerging markets 4Q 2011 16.0 % 13.5 % 13.2 % like China and South America, American real estate is still the 3Q 2012 15.5 % 13.1 % 12.9 % top investment choice globally, according to the Association 4Q 2013 14.8 % 11.3 % 11.7 % of Foreign Investors in Real Estate (AFIRE). Source: CBRE Econometrics Advisors An AFIRE member survey found 60 percent of the responThe nonresidential sector includes commercial, industrial dents plan to increase their American investments in 2012, and institutional building projects. Specifically, the 2013 and these investments are regarded as the best opportunity for forecast for commercial construction, comprised of offices, capital appreciation. Top nonresidential international investments are, in order, hotels, retail and other business buildings, is 10.2 percent growth, double the 2012 rate. Hotel construction is expected industrial, office, retail and hotel. New York is the No. 1 city globally for investment. to jump a whopping 18.2 percent. On the other hand, industrial construction isn’t predicted to do Growth of Construction Activity as well. In fact, the forecast is for 8.1 percent growth in 2013, down Year Office Industrial Institutional Retail from an expected 12.9 percent growth during 2012. Institutional construction – health, education, public safety, 2010 -27.1 % -29.0 % -14.0 % -27.0 % religious and amusement – is forecast to increase a modest 3 -8.5 % 2.6% -4.0 % 10.4% percent in 2013, but four times the .7 percent 2012 growth. 2011 Health, religious and amusement are the top categories here. 2012 4.7 % 12.9 % 0.7 % 6.2% These expectations are especially good news in light of 8.7 % 8.1 % 3.0 % 9.0 % continued slow economic and job growth and the lack of a 2013 Source: U.S. Census Bureau robust housing recovery – aspects of the economy that usually Nonresidential lending is also on the upswing. Troubled lead demand for new commercial facilities. Because new construction has been so slow, the small properties are making their way through the system as they amount of job growth means vacant buildings are being are resolved through foreclosure, sale or restructuring. The occupied at a higher rate than might be expected. Declining default rate is also dropping steadily from the peak reached in vacancy rates are being seen in office and industrial buildings. 2010. As a consequence, banks have been able to loosen credit Retail is continuing to struggle and will do so until consumer slightly and originate more new loans. Capital access is crucial spending fully rebounds. An important element of the nonresidential market is for construction projects to move forward, both on the equity foreign investment, accounting for more than 10 percent of and debt sides. The recent Federal Reserve decision to buy $480 billion in dollars invested, according to Real Capital Analytics. See Nonresidential Construction continued on next page The recent extension of the EB-5 Regional Center Program

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Jan./Feb. 2013 Building For Success


Kids anxious to move out of parents’ homes

Pent-up demand signals more apartment construction

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ultifamily construction spending is up 15.8 percent for the first six months of 2012 over the same period last year, according to Reed Construction Data. Starts are up, too, with a total of 269,000 units for the year predicted by the National Association of Home Builders. This is welcome news after multifamily construction hit record lows in the last half of 2009 and early 2010. About 500,000 units were started in 2005, so the industry is still way down from top production. Top metro markets for multifamily construction are New York, Washington, D.C., Los Angeles, Miami and Boston. In the second quarter of 2012, the vacancy rate index was at 36, the same as 2011 but far better than 2009, which had a high of 70, reported the National Association of Home Builders. The index is based on high and low vacancy rates. Overall vacancy rates have improved in 2012 to 8.6 percent from 9.4 percent in 2011, U.S. Census data show, although buildings with five or more units are still at 9.4 percent. Regionally, vacancy rates were highest in the South (11 percent) and Midwest (9.1 percent). Vacancy rates were more favorable in the West (6.2 percent) and Northeast (6.7 percent). One factor sure to affect future construction activity is pent-up demand. With the lingering recession, people are living with relatives or roommates far longer than usual. The usual rate of new household formation from children

Nonresidential construction continued from previous page

mortgage-backed securities over the next year will likely benefit the commercial real estate market, says John O’Callahan, real estate analyst for CoStar Group. The move is expected to otel construction lower commercial borrowing is expected to costs and make long-term jump a whopping investments more attractive. In 18.2 percent. particular, real estate investment

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leaving home, divorce, college graduations and other life changes is 1.2 percent, the National Association of Real Estate Trusts reports. During the past several years, this rate has dropped to 0.5 percent, resulting in pent-up demand of two million units. With an estimated 500,000 shortfall in constructed units, the total is 2.5 million. Helping boost the industry is support from the government-sponsored enterprise Fannie Mae. Fannie Mae issued $22.3 billion in mortgage-backed securities between January and August this year for the multifamily market. This has encouraged banks to lend, and with interest rates remaining below 4 percent, demand for loans has been strong. Multifamily housing supported by low-income tax credits and other subsidies accounts for about 30 percent of projects. ■ trusts (REITs) are expected to benefit from lower costs. Although building values have been stabilizing, the Federal Reserve initiative could boost equity further, creating wealth for investors. In turn, the rising benefits of real estate investment should spur additional building projects. Issues to watch in 2013 include Congress’s handling of the national debt, expiring tax cuts, oil prices and the European economy. – Elizabeth Penney, M.B.A. ■

Controlling Construction Costs continued from page 1 the average hands-on working hours. If you frequently pay overtime, include a factor for that. This gives you a more accurate basis for preparing bids as well as managing productivity. In today’s environment, productivity is even more important. Put together the best team you can, which of course, includes congeniality and good customer service in addition to fast and accurate work. A solid team can help you manage the project efficiently and minimize mistakes and do-overs. Experienced employees or subcontractors are a knowledge resource. If jobs are done in a timely manner to the customer’s satisfaction, everyone benefits. Quality improvements and productivity gains can save as much as 7 percent on a project, according to Paul Hessler of Construction Business Associates, LLC. Consider bonuses for time and materials savings to motivate your team. Materials are another major cost center. Unfortunately,

their cost is in large part out of the contractor’s control. For instance, depressed construction demand is pressing builders to absorb price hikes. Sometimes prices leap during a job, eating up profits. Since demand for building materials is global, they are subject to shortages, bottlenecks and high transportation costs. Some companies are stockpiling materials common to jobs, such as lumber and steel, to hedge against price surges. There is some risk, but the materials can always be resold. Others are negotiating materials contracts ahead of time to ensure supply and negotiate prices. Onsite purchasing can boost costs 2.5 percent, Hessler asserts. Materials with wildly fluctuating costs can be handled with a provisional allowance until the project starts, when the price can be locked in. This is an alternative to the practice of adding percentage increases in advance and allows adjustment if prices go down or stabilize. – Elizabeth Penney, M.B.A. ■

Jan./Feb. 2013 Building For Success

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Home improvements often cost more than expected

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urphy’s Law is alive and well, at least when it comes to ▲ home improvement projects, according to a new study by Consumer Reports magazine. Nearly half of homeowners doing major home improvements found that if something could go wrong, it did. More than 17,000 consumers were surveyed about projects ranging from painting to remodeling kitchens to adding new rooms – 30,000 projects in all. Of them, 44 percent said they spent considerably more money than ▲ anticipated and experienced a variety of unexpected problems. The primary reasons given for going over budget were: ▲ Buying the wrong products ▲ Encountering surprises, such as delivery charges ▲ Paying debris-removal fees ▲ Using a contractor who underestimated expenses, ▲ did poor work or didn’t anticipate code requirements The consumer group gives several tips to homeowners, some of which include advice concerning contractors: ▲ Make a plan and stay with it. Many of those who went over budget did so because they changed their minds in the middle of the project. Building For Success

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Beware of lowball estimates. Bathroom remodel 60 % Some contractors may Kitchen remodel 56 % underbid a project and then Basement finishing 56 % try to make up the differRoom addition 55 % ence as the project goes Deck addition 45 % along, the magazine said. It urges homeowners to beware Major landscaping 45 % of open-ended estimates. New windows 33 % Check the contractor’s Interior painting 31 % references. Consumers are urged to be sure the contractor has up-to-date licenses, insurance and worker’s comp insurance. They are told to ask for a list of every product used, down to the model number to avoid unexpected incidentals that add up. Have financing in order. Consumers are told to be sure closing costs and interest rates are in order before the project begins, and to be sure their contractor adheres to local codes. It’s a red flag if the contractor asks the consumer to get their own permits. Homeowners should have a flexible maximum amount available in case the project does go over budget. ■

The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS. © 2013 CPAmerica International

100 Second Avenue South, Suite 600, St. Petersburg, Florida 33701 www.gsscpa.com | gss@gsscpa.com

(727) 821-6161 If we may answer any of your questions on the information contained in this publication, please contact us.

Overrun $600 $1,200 $1,350 $2,000 $700 $735 $600 $280


Building For Success Newsletter January and February 2013 Edition