Minimizing Risk, Controlling Costs and Sourcing Materials in Today’s Challenging Construction Environment

by Katie Sloan

Delivering student housing projects in today’s environment takes more than just a skilled design and construction team. One must be creative, nimble and flexible — ready to face new challenges at the drop of a hat, from unexpected supply chain issues to labor shortages, pricing volatility and everything in between, all while working towards a hard fall delivery deadline. It’s tough out there, but with proper planning and constant communication, developers and general contractors are still completing projects on-time and on-budget.

What follows is an edited transcription from the panel “How Best to Control Costs and Source Materials in Today’s Challenging Construction Environment,” which took place during this year’s InterFace Student Housing conference in Austin, Texas. 

The discussion includes Giny Knudsen, executive vice president with Construction Enterprises Inc.; David Mellema, director of pre-construction services with Weitz Co.; Chad Matesi, COO of Core Spaces; Marty Hoffey, business development manager at MW Builders; Jason Doornbos, head of development for Landmark Properties; and moderator Mark Knott, vice president at Project Management Advisors.

Knott: For me, one of the biggest questions is how has your approach changed over the past year? Do you have new standard operating procedures to minimize risk?

Hoffey: With the volatility in the market right now and subcontractors holding their prices for as little as three days, aggressive buyout is key in every project now. We will get a guaranteed maximum price (GMP) signed and we’ll lock our project managers in the conference room for a couple of days going and buying out everything ‘possible,’ every long-lead item to try to lock in as many prices as possible because a week later, those bids could be long gone and more expensive. For example, we just signed a 600-bed student housing project in Indiana and we were there for 24 hours negotiating with the lumberyards to get the lumber packaged and bought at that price on that day. Then we figured out where to store it for the next eight months. 

Mellema: We try to attack the buyout as hard as we can. The goal is to get bought-out in 30 days if possible, but sometimes it has to be faster than that. One of the bigger challenges that we’re struggling with is trying to figure out warehousing and early purchasing, and then getting our development partners to understand that you might need to spend a bit earlier than usual to purchase materials and possibly warehouse them. We have a project in Healdsburg, California, that we’re just at the structure phase of and we’ve already bought all of the roofing insulation and it’s warehoused on our site. Prices are only good for a couple of days and you have to purchase early and lock those in. 

Knudsen: We’re in the same boat. I think we all are singing the same tune. We have been trying to tie-down early buyout as best we can. We are very fortunate to have good relationships with a lot of great subcontractors. As soon as we know the job — even before the GMP is signed — we try to bring them on and make them partners with us. And then of course warehousing. The first thing that we do when we get a new project that we’re looking at is canvas the area to see if there is a lay down yard or warehouse that we can rent for materials because that has to be included in the GMP now. 

Knott: Chad (Matesi), are you finding new ways to partner in this environment?

Matesi: We are. We are relying heavily these days on our trusted construction partners, and a lot of it is just information gathering and trying to cut through the noise and get to the truth. We’re in communication with our third-party contractors on a daily basis. We have internal teams of analysts that are tracking material indexes — we’d never thought about doing that in prior years. We’re actually looking at the lumber index on a daily basis in our executive reports. The biggest change for us in terms of truly trying to mitigate risk is doing everything possible to eliminate every single allowance within a GMP. We’re spending money earlier, getting to contractors earlier and locking in as much as we can as early as we can. In the good old days, we could get comfortable taking a decent number of allowances within a GMP, but that’s just not the case in this environment. 

Knott: Having that certainty is key. Having a partner in place is what we’ve seen to be the most successful approach. It allows you to forecast some of the long-lead items like roofing, light switch gear and insulation. When you look at those components from the development side, how are you counting for that escalation?

Doornbos: We’re getting a full set of construction documents by the time we’re getting our GMP in place to remove any kind of uncertainty in the contract. From the development point of view, we’re working much closer with our architects and construction teams. We want to ensure that we’re pricing and re-pricing as cost escalation occurs, while constantly touching base with subcontractors to be sure that we don’t have a large budget bust upon closing. We’re working close, value engineering plans throughout the process to make sure we have a budget that we’re comfortable with and building in contingencies. We’re beginning with a higher contingency, and by the time we’re getting ready to start, we’re trying to get down to 5 percent. Sometimes when you first start looking at a project, you’ll be carrying a 10 percent contingency factor. 

Knott: That 5 percent is consistent with your historical contingencies?

Doornbos: Yes. That’s what we try to carry. 

Knott: There is nuance in what we’re preparing our different projects for due to the different cash-flow models. Have all of these large deposits and purchases up-front modified anything in terms of how you’re working through the development process?

Hoffey: It starts with the cash-flow. We’re being asked for cash-flow models early in the project because the old days of the bell curve are far gone. Now it goes up very quickly, which adds interest costs for the developer, so they want to see very early in the process how much we’re going to buy out early so that they can adjust their financing. 

Knott: Obviously keeping with your development schedule is important. August delivery is a key focus in student housing and material availability is a driving factor in achieving that goal. Going back to that long-lead component, when do you have to lock in these decisions?

Knudsen: We’re having to partner with our developers and try to do that for them if we can, but tying down things can be tricky. One day they’ll tell you one thing and then the next day, it’s ‘oops, sorry, you have a signed contract? Too bad.’ It’s very difficult to mitigate the waters that we’re treading right now. We all have to come to the table with a partnership attitude — developers, owners, contractors and subcontractors. 

Mellema: We’ve always had long lead-time items on our initial schedule, it’s just that the list has grown. We’re including items like switch gear and some of the things that we might not have traditionally thought about early, like generators, which can be 52 weeks to 70 weeks out. We have to plan early, and really the key is making sure you’re having conversations with your partners early. 

Knudsen: And the order of buyout has drastically changed. You’re buying doors and windows before you even have a site package. It makes no sense and throws planning out the window. You just really have to consider the location where you’re working and the type of products that are required for construction. The playbook has just been totally destroyed.  

Knott: Jason (Doornbos), staying on that topic, Landmark Properties is vertically integrated. Are you releasing some of the materials on your own and buying and securing items in advance for your construction?

Doornbos: Absolutely. Just like the third-party general contractors, we’re warehousing materials, windows, doors — any of the materials that are challenging to obtain right now. We’re trying to get out as far ahead of it as we can to warehouse those so that there is not an issue at the last minute. 

Knott: One of the things that this type of risk brings is some tension around contracting — both upstream and downstream — with our development partners and with subcontractors. Are you finding creative ways to mitigate tension in those areas?

Hoffey: With the volatility of pricing right now, sometimes we can’t lock in numbers at GMP times, so we have to share some risks with the owner. The biggest thing that we do now is we ask to have all of the contracts signed by the day we give the GMP. In the good old days, you’d get the GMP and you’d spend the next couple of weeks with attorneys ironing things out, crossing t’s and dotting i’s. Now, we need to have it signed that day so that we can start issuing purchase orders, subcontracts and buying material. It’s just pushed the whole schedule up a little bit. 

Knudsen: We’re doing the same thing. We’re negotiating contracts at the same time that we’re pricing a project. You don’t even know that the numbers will work but you’ve got to get the terms ironed out. Our subcontractors are putting escalations into their contacts and we’re having to pass that along. It can be very tense sometimes to talk through them. We talk about it being a shared risk and it definitely is. It is not always proportionate, and that is the real world, but I do the contracts for our company and I can tell you that I’ve seen things in our contracts over this past year that I never dreamed would fly. But they do right now anyway, and that’s because the money is still there to accomplish these projects, even as high as they are and as crazy as the market is. 

Mellema: We’ve always been really big on pre-qualifying subcontractors and making sure that we have the right partners in hand, and that has become even more important in today’s environment. It can’t always just be the low bid. It has to be the bid that you believe in, the guys that will stand behind it, and somebody that will give you a number that can actually be locked in. It’s a subcontractors market out there right now because if they don’t like their project, there’s another one that they can go bid on. You’ve got to be appealing to your trade partners and you’ve got to have the right partners to make it work. 

Knudsen: Along those lines, we’re finding that it depends on the degree of difficulty of the project. Subcontractors can be selective and if it’s a difficult project with a difficult schedule, they don’t need it. They have three more behind it just waiting to take onboard. It really makes a difference in the type of project that we’re pricing too. 

Doornbos: As much as it kills me as a developer, a lot of times we’ll go through a leveling exercise. When we get our quotes from the general contractor, we’ll actually increase our budget based on the numbers we get just because we’re going through and adjusting scope with allowances. We’ll talk to our local subcontractor base and get a feel for where we think costs are and if we think costs are low, and line items will actually increase those a lot of times. Because of that, I think capital really trusts us more than some other groups. Their thought would be, ‘we believe in these numbers and we see them from Landmark, we feel like if we close on this transaction, we’re not going to have an immediate budget issue with them.’ As a result, we’ve been able to get projects capitalized at lower yields just because there is a trust factor in the construction numbers we’re showing our partners. 

Knott: Chad (Matesi), is Core Spaces getting creative with its contracting form? Or when you contract?

Matesi: I don’t know that we’ve gotten too outside the box in getting creative with contracts. It’s really all of the work upfront where all the difference is coming right now. 

Knott: The last contract I signed, we met in the middle and created an escalation contingency and a 90-day threshold with which the general contractor was required to buy out in 90 days to pull any money out of the contingency pile and have submittals done within 120 days. The speed was there, the urgency was there, and if they did their job in that manner, they had access to those funds. Sometimes materials aren’t even priced until they’re shipped, which can be six to eight months later. How are you guys dealing with that process from the construction side?

Hoffey: It’s funny, I was looking at an email before I came here about a project we’re working on. We’re looking at metal panels for the side of the building, and the supplier said that we have to buy them within 30 days, we have to take delivery within 100 days, and the warranty starts when they ship. That’s what we’re dealing with right now. We’re going to have to warehouse them for a year before we need them. Something new and crazy comes in every day. 

Knott: From our side, we try to develop partnerships. We see value in engaging contractors with our development partners and architects early. To that point with some of the timing components and working through those GMP pieces, we see a lot more engagement. As a percentage, I’d like to hear where you guys are from the construction side of pre-con agreements and early contracting. Is anyone still doing design-bid-build? Or is it all partnership driven?

Hoffey: It’s pretty much all partnership driven now. 

Knudsen: Ours is too. 

Matesi: Ours is also all partnership.

Mellema: Same. We had already been in the habit but we’re even more so in the habit of making sure we get a contract from a developer early. We redline it before we get to the spot of the GMP, and we have those conversations early so that when we provide a GMP, we really are able to get to a contract quickly. If we can get to a contract quickly, we can buy it out quicker and all of that will go a little bit more smoothly. It’s really the pre-game that helps us get there more than anything. 

Knudsen: And a lot of times it is the terms of the contract that help drive the price. How many contingencies or allowances are going to be in the contract? And if they’re there and adequate, then that might impact the pricing of the contract. 

Katie Sloan

This article was originally published in the May/June 2022 issue of Student Housing Business magazine. To subscribe, please click here

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