Construction Contingency: Everything You Need to Know

Construction Contingency: Everything You Need to Know

When starting a new construction project, success can be determined by your understanding of the loans, fees, and costs involved. Here is your crash course in construction loans and contingency. We will go over different types of loans, how to get them, and the contingent costs associated.

Key Takeaways

  1. A contingency fund is used to cover the cost of unexpected costs that may arise during construction.
  2. The contingency price will depend upon the type of contract used in your project.
  3. Statistically speaking, a project is bound to run into some sort of problem so a contingency fund is vital to a project's viability.

What is Construction Contingency?

Construction Contingency is a fund for unexpected costs that may occur during construction; it helps mitigate the risk involved with any construction project. The AIA (American Institute of Architects) defines construction contingency as "a predetermined amount or percentage of the contract held for unpredictable changes in the project." Essentially, a percentage of money is set aside to cover risk factors, but it is not reserved for any specific area of work. Contractors, designers, and owners will cite different reasons for digging into the contingency fund.

What are the Different Types of Construction Contingency?

The different types of construction contingency refer to the various factors that may warrant the use of the contingency fund. For example, supply chain issues might disrupt the materials so contractors will use the contingency fund to purchase alternative materials. Let's take a look at the most common categories of construction contingency…

Design Contingency

A designer is responsible for the aesthetics of a construction project. They handle choosing and planning the layout of materials used in construction. A designer could run into issues if a manufacturer is sold out of certain materials. They might use the contingency fund to cover the cost of alternative materials.

Owner's Contingency (Owner Reserve)

Law Insider defines Owner's Contingency as "the amount of funds included in the contract that represents the Owner's best estimate of funds to provide for unforeseen circumstances or conditions that may arise during the construction of the project" Likely, they will use it to purchase additional materials that will increase the value of their project. For instance, if the owner is doing a kitchen renovation they might use a contingency fund to purchase a more durable stone for the countertops.

Contractor Contingency

It is important to note that contractor contingency is not the same as the owner's reserve. The owner's reserve is a personal fund while Contractor contingency is agreed upon in a contract. Contractor contingency is far more restrictive. At the start of a construction project, the owner and the contractor will agree to a contingency amount alongside an outline of the specific reasons as to why they would use the contingency fund. Common construction contingency examples for contractor contingency could be…

  • Cost overruns due to estimation errors
  • Weather delays
  • Costs to address safety
  • Unanticipated material price changes
  • Scheduling changes

The use of contingency funds is often disputed between owners and contractors. So, it is important for contractors to set up a contract that spells out all costs, including contingency fees. A construction contingency must have a thorough proposal discussing how to access the funds, what they should be used for, and the overall price. Here we will discuss the two most common types of construction contracts and how they affect contingency.

Fixed-Fee Contract

In this sort of contract, the contractor is wholly responsible for the risk involved with the project. The contingency fee is included in the total contract price and often times the owner does not realize that the contingency fee is included. So, the owner is typically not involved with setting the contingency price. If the contingency fund is unused or partially unused, the remaining funds will become profit for the contractor.

Cost-Plus-Fee Contract

Before discussing this type of contract you must understand GMP. GMP is the guaranteed maximum price that is set by the contractor to set a limit on the total price after fees. Contracts without a GMP often end in dispute because of higher-than-expected costs. In this sort of contract, "Included in this GMP is a contingency line item to take care of bid overages, reasonably inferred items and other project-related items that may arise during construction." The base cost plus fees should be the GMP. After the GMP is set, the owner bears no responsibility to cover costs beyond the GMP. If costs exceed the GMP then the contractor is responsible for those costs.

Why is Construction Contingency Important?

Construction Contingency exists as a safety net against construction risk factors that could delay or disrupt the project. The contingency budget does not imply that the project is a financial risk. Rather it is simply protection for the project. Preparation for disruptions will allow the construction team to manage additional costs smoothly.

Some might look past the importance of a contingency fund because it seems like an unnecessary expense for factors that do not have a high rate of occurrence. Statistically speaking though, a project is bound to run into some sort of problem. Whether it be large or small, owners and contractors should be prepared in the face of risk. Your real estate project will only be as good as the work you put in before the start of construction. If you recognize risk and actively safeguard against it, then your project will be in great standing by the start of construction!

📌 All construction projects are riddled with uncertainty and risk. Although contracts will differ when addressing contingency, it should always be included. It is in the best interest of all parties involved to ensure that Construction Contingency costs are properly accounted for prior to the start of construction.

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