By Rishi Grover | Originally posted on venasolutions.com
The construction business comes with its own particular set of challenges, from scheduling conflicts to safety issues. Costs can unexpectedly inflate and demand can be unpredictable.
Real estate developers and industry pros rely on construction budget management to navigate these challenges. But, issues like unpredictable weather, fluctuating material costs and worker shortages make construction project budgeting a complex ordeal.
Although it’s impossible to anticipate all the wrenches that might be thrown in your plans, you can adapt to them quickly with access to the right data and the right agile planning processes.
In this blog, we’ll explain how the challenges we mentioned earlier affect the construction industry and how you can better manage your construction projects despite them.
Key Takeaways
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The construction industry faces ongoing challenges around fluctuating material costs and insufficient labor.
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As these pressures increase, construction firms must lean on robust budget management processes built around data they can trust.
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Centralizing data, implementing value engineering and using escalation clauses are a few ways construction firms can build a margin of safety in their financial forecasts.
The Challenges Complicating Construction Budget Management
Changing political and macroeconomic trends have created significant opportunities in the construction industry. Reshoring has steadily gathered pace (evidenced by increased mentions in earnings calls transcripts) and the 2021 Federal Infrastructure Bill has led to more investment in non-residential construction projects.
However, this increase in demand has coincided with new challenges, creating volatility in construction budgets. These challenges are:
- A lack of materials is creating overruns
- Labor shortages are extending timelines
- Fluctuating material costs are creating unpredictability
- Unpredictable weather threatens profitability
Let’s look at how these factors are complicating construction budgeting in more detail.
A Lack of Materials Is Creating Overruns
The COVID-19 pandemic strained global supply chains and, unfortunately for the construction industry, the supply chain headaches have not gone away.
Speaking to Construction Dive, Raylena Browning, Vice President of Preconstruction at Manhattan Construction Co., says that electrical switchgear, generators, and AV components have lead times of 42 to 60 weeks, for example.
In most cases, a lack of domestic suppliers is forcing construction firms to deal with time overruns that have a knock-on effect on the rest of the project. A side-effect of these overruns is the reputational harm they cause, potentially jeopardizing future business.
Labor Shortages Are Extending Timelines
Labor shortages have long been a fixture of the construction industry. However, the gap between construction demand and worker supply is widening alarmingly.
A 2023 study by Associated Builders and Contractors (ABC) highlighted that contractors across the US faced a shortfall of 546,000 workers. That number has since grown.
ABC predicted that 3,260 new jobs will result from every $1 billion in additional construction spending, resulting in a projected employment gap of 1.6 million construction professionals in 2024.
ABC’s research indicates a potential 1.6 million shortfall in the construction labor market. Credit: ABC
These shortages are fueled by a cycle of older workers retiring and young people shying away from the sector—creating cost overruns and increasing direct costs.
Fluctuating Material Costs Are Creating Unpredictability
While increased expenses are straining profit margins, price volatility is one of the biggest challenges for construction budgeting currently. The construction industry witnessed some price stabilization in 2023, but 2024 has brought a significant swell in input costs.
Input prices rose 1% in January, according to ABC, kickstarting a trend of rising prices. Prices peaked in April, fueled by rising inflation and interest rates, before decreasing over the next three months.
Despite this decrease, construction input prices remain 1.1% higher compared to a year ago, with market observers expecting more volatility. ABC chief economist Anirban Basu expects more challenges due to higher interest rates.
“The Federal Reserve is still looking for data indicating that 2% inflation will soon be re-established, so data like these may forestall much-anticipated and desired interest rate cuts,” he said in an ABC press release. “That translates into higher interest rates for longer, which would damage construction industry prospects.”
In short, builders and construction companies can continue to expect squeezed margins and continued volatility from input prices.
Unpredictable Weather Threatens Profitability
The construction industry heavily relies on stable weather, and current weather patterns are anything but. Research published in the journal Geophysical Research Letters states that extreme atmospheric conditions (that give rise to hurricanes and tornadoes) have significantly increased over the past 40 years.
Construction industry professionals don’t need a research paper to validate this fact. For instance, recent rains and flooding in California have created significant property losses with many residents in low-lying areas dealing with mudslides and floods as a new normal.
These disasters stress the need for flexibility and a wider margin of safety in construction budgets.
While these risks might make staying on top of construction budgets an impossible task, there are ways for you to cope with these new challenges.
4 Construction Budget Management Tips To Navigate Unexpected Changes
So how do you manage your construction projects effectively, in a way that takes into consideration the challenges we’ve listed above?
Adding efficiency to your financial planning is the answer. But how do you add efficiency in practical ways?
Kyli Lane, chartered accountant and Solutions Consultant for Vena, says anticipating economic changes throughout the project is critical. “There are various factors companies need to have a pulse on every month, every quarter—reporting to their investors to see ultimately what that anticipated return is going to be,” she says.
Aside from adopting a mindset of expecting change, here are a few construction budgeting tips you can practice to lessen the impact of the disruptions we covered earlier:
- Establish a single source of truth for your data
- Lean into value engineering early
- Use escalation clauses
- Increase takeoff accuracy
Let’s dive into each of these.
1. Establish a Single Source of Truth for Your Data
Your budget’s accuracy depends on data, and construction projects need a lot of it.
Manual data gathering is inherently prone to data entry errors that can balloon into massive lapses in decision-making. Worse, manual processes destroy trust in your data—a harmful outcome in the long run.
Connecting your various data sources and bringing them into a single dashboard will help you make decisions faster and more accurately. For instance, connecting your HRIS systems to your ERP/GL platforms will help you calculate and project labor costs accurately.
With all your data in one place, you can wave goodbye to chasing datasets through several spreadsheets and wasting time manually entering data.
2. Lean Into Value Engineering Early
Value engineering—a method of examining your project’s assumptions and increasing margins—is essential when dealing with financial volatility. It gives you a greater margin of safety in your budgeting and forecasting.
Note that value engineering is not simply about reducing costs. Instead, it’s about making the most cost-effective decisions. Let’s walk through an example where you have to choose between the options below:
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Option A – Fixtures that will arrive immediately but are expensive.
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Option B – Fixtures that are 10% cheaper than A but will arrive in three weeks.
Value engineering weighs the pros and cons of both options and chooses the one with the least negative impact on the project. In this case, Option B might be cheaper but could result in timeline overruns, increasing overall costs.
Sometimes, this might mean compromising on your vision, Kyli says. “What happens is developers will partner with an architect and they’ll dream up the design—they may have these amazing ideas. But then they do a budget, and it’s not as robust as it could be. And then, corners are cut.”
Collaboration, scenario planning, and variance analysis are critical to value engineering success and avoiding the scenario Kyli highlights. These processes are made easier when you have a tool that can consolidate your budgeting, reporting and analysis in one place.
3. Use Escalation Clauses
Even the best financial planning processes can’t account for macroeconomic shocks. This is where escalation clauses—which, in construction contracts, help protect contractors against surging material costs—come in handy.
Robert Alfert, partner at law firm Nelson Mullins Riley & Scarborough, recommends escalation clauses as standard practice in construction contracts. “While this may sound provocative, the private market reality is this: Hard lump sum and guaranteed maximum price contracts are a thing of the past, at least for the near-term future,” he writes in Construction Executive magazine.
He recommends builders discuss and set price increase thresholds with subcontractors, aiming to spread price volatility risk. Robert even suggests exploring buying materials in bulk early and storing them to lock in prices.
Of course, this method demands robust financial forecasting abilities built on a trustworthy data source.
4. Increase Takeoff Accuracy
Given current material price volatility and supply chain delays, creating an unrealistic takeoff (the estimate of the quantity of materials needed for a project) is all too easy to do, unfortunately. One way to build accuracy is to share your takeoffs with suppliers and confirm your price estimates.
For instance, a supplier might plan a price increase cycle midway through your project, potentially causing an unacceptable variance. Collaborating with them helps you avoid this situation.
Additionally, examine your assumptions in each project phase. Go granular by looking at cost codes and breakout activities by phase.
Reduce Financial Risk With Robust Construction Budget Planning
Navigating the unpredictability of the construction industry demands robust tools that help you build flexible financial plans. No matter the challenge, more frequent and accurate forecasting, scenario planning, and data-driven decision-making never go out of style.
Lean on construction FP&A technology that powers these processes and you’ll successfully overcome any challenge the market throws at you.
