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A project owner’s budget for implementing a capital project is a critical factor driving the project’s scope (extent), quality, and schedule. For this reason, project owners often retain the design professional, construction manager as advisor (CMa), or a construction cost estimating consultant to prepare opinions of probable construction cost (“construction cost estimates”). Owners typically expect reasonably accurate estimates of both the project’s bid or proposal prices, prior to award of the construction contract, and the final cost of the completed construction.

It is challenging to accurately estimate construction costs in the best of times but, during periods of construction cost volatility, preparation of reasonably accurate construction cost estimates becomes especially challenging. Recent examples of construction cost volatility include 2000-2009, when economic growth in East Asia significantly drove up costs for many construction materials, and the aftermath of the 2020-2022 COVID-19 Global Pandemic, which resulted in increased manufacturing and transportation costs, and delayed deliveries. Such supply chain issues may be limited to selected materials (as in the 2000-2008 period of east Asia economic expansion) or across the board (i.e., labor, materials, and equipment), as resulted from the COVID-19 pandemic. Market forces driving such cost volatility and supply chain issues are typically difficult to anticipate and can play havoc with the accuracy of construction cost estimates.

Construction materials most commonly affected by cost escalation include: steel, stainless steel, and related alloys; copper; PVC, other materials with resin, such as fiberglass-reinforced plastic (FRP); cement; and lumber and engineered lumber products.

This blog post generally addresses: (1) consequences of inaccurate construction cost estimates, (2) basic construction cost estimating practices, and (3) establishing with the project owner appropriate expectations for the accuracy of construction cost estimates. A brief listing of alternatives for addressing, in the construction contract, cost escalation and supply chain challenges is presented near the end of this blog post.

Consequences of Inaccurate Construction Cost Estimates

The consequences of inaccurate construction cost estimates prepared by the project’s design professional, CMa, or construction cost estimating consultant include:

1. Embarrassment and frustration for the project owner, which often does not reflect well on the entity that prepared the construction cost estimate. This has potential to adversely affect the design professional’s and, perhaps, CMa’s future business opportunities with the owner and perhaps others.
2. The owner’s budget is inadequate for the project. This may result in:
3. Delay in project implementation, which would delay the owner’s benefit gained from constructing the project and, for the design professional and CMa, delays in employee utilization and realization of the design professional’s and CMa’s profit.
4. Owner’s delayed implementation of other projects in its capital improvements `program.
5. For public owners, potential adverse publicity. This may include mentioning in the media the design professional’s and CMa’s connection with the project and, perhaps, the reasons for its delayed implementation.
6. For projects with funding or financing from third-party entities, such as a grant or low-interest loan from one or more governmental agencies, the owner’s eligibility for the funding or financing may be delayed, jeopardized, or otherwise adversely affected. For example, where a government low-interest loan of a specific amount represents the project’s entire budget, bids or probable costs that exceed the approved loan amount may jeopardize the entire project. Also, owners or developers may delay projects due to concern over financier’s uncertainty to commit to long-term financing.
7. Lack of available funds may prompt the owner to require changes in the design to reduce construction costs. When such changes are directed as a result of a perceived lack of accuracy in the design professional’s or CMa’s construction cost estimate, the design professional’s chances of being properly compensated for the design changes may be reduced. Such changes may also result in decreased service life for the facilities constructed under the project and/or increased operating and maintenance costs incurred by the owner, for less-efficient systems that have a lower construction cost.
8. Other adverse effects, such as an owner’s demand that the design professional or CMa reduce its compensation for services performed as a means of helping the owner partially close its budget shortfall.
9. A difficult construction phase, when the project owner seeks to limit or restrict increases in the construction contract price, even when such increases are legitimate and perhaps unavoidable, which may, in turn, result in increased change proposals, claims, and disputes between the parties to the construction contract. Such situations are often stressful and challenging for all participants, and the design professional consultant is often a convenient target of the contractor, CMa, and owner. Such projects often result in decreased profitability because design professionals and CMa’s rarely budget their services in anticipation of difficult, contentious construction.
10. Degraded business environment on subsequent capital projects, with potential for reduced competition and further-increasing prices, as contractors, subcontractors, and suppliers bidding or proposing on future projects either refuse to participate or add hidden contingencies to their pricing.

To reduce the potential for the adverse consequences indicated above, the design professional’s and CMa’s project teams should: (1) employ due diligence in preparing and documenting the basis for construction cost estimates; (2) establish and clearly communicate to the owner appropriate expectations regarding the probable accuracy of the construction cost estimates; and (3) discuss with the owner alternative contractual approaches for managing the risk of construction cost escalation and supply chain challenges.