So, you're an entrepreneur and you have an important building project.
(article continues below)
You secured the land, hired a contractor, closed on a construction loan, hired architects and engineers, and gotten all the necessary government approvals. You are ready to start building! So what can you do now to manage your construction budget? It's not as tricky as you might think. In fact, there are a few things you can focus on to help keep your costs in line.
Lock in A&E Costs
You probably locked in a budget with your contractor. This is smart, and most people focus on controlling the contractor's costs. But don't forget that as much as 15% of a project's cost can come from Architecture and Engineering fees. Do your best to lock in a fixed fee with these folks and get them to help you control costs. If they want to just be a percentage of the total cost they have no incentive to help you keep things in order – especially if this is the only job you ever use them on.
Get a Detailed Cost Break-Down and Schedule
As your project begins you should ask for a schedule from your contractor. But rather than focusing on the completion date, have your contractor help you identify which of his sub-contractors will be requesting payment at each phase of completion. The concrete, steel, and site contractors will require payment early – the plumbers, dry-wall crews, and painters at the end. If you can map this out in advance you will be able to estimate how quickly you will draw down your construction loan. This will allow you to estimate your interest payments more accurately.
Prepare and Review Monthly Draws
Your construction lender will probably allow you to make monthly draws on your loan. A construction loan functions like a line of credit. You get approved for a certain loan amount, and then begin drawing on it. Each monthly pay request is called a draw.
Go through your pay requests from the contractor and all architects and engineers with a fine-tooth comb. Make sure that you are not paying them any faster than necessary. Remember, you only pay interest on the amount of the construction loan that is outstanding! Being approved for an $18 MM construction loan at 7% interest doesn't mean you pay $1.26 MM in annual interest. You only pay what you have taken in draws.
While reviewing draws go through invoices carefully and compare them to the previous requests from each contractor and engineer. Make sure that their invoice didn't overlap with your previous payment. If you overpay a contractor it is very difficult and time consuming to get things straightened out again.
Use Contingency Funds Wisely
Almost all construction loans will require a line item for contingency. Commercial projects usually have at least 5% contingency allocated to cover unexpected items. These items are called change orders. Make sure that along with your monthly draw you keep good track of change orders and ensure that your contingency is enough to cover the change orders. If you use your contingency too quickly you may have to fund the over-runs with your own equity. Finally, make sure that the change is really something you need to pay for. The contractor should cover his mistakes out of his own contingency.