Freddy Munoz and Brett Moritz | Peckar & Abramson
The impact of these price increases is being felt across a wide spectrum of projects and is beyond what could have reasonably been expected.
Between the onset of the COVID-19 pandemic in March/April 2020 and mid-May 2021, lumber prices have risen an incredible 308% according to Yahoo News. Steel prices have also risen over 60% according to Trading Economics. These increases, among others, led the Associated General Contractors of America to issue a construction inflation alert, something that the group had not done since 2008. While the reasons for the price increases are too numerous for this article, the question remains: how can construction industry participants minimize the risk of ever-increasing prices?
The impact of these price increases is being felt across a wide spectrum of projects and is beyond what could have reasonably been expected. It is not just owners, contractors, subcontractors, and material suppliers on commercial and civil projects who are feeling the brunt of this price inflation—average consumers are also being affected. As an example, if you recently purchased a house or are in the process of a small renovation project, you have probably been impacted by the rapidly increasing materials costs. But how can the risks associated with the increasing costs be managed effectively to mitigate the risk is the question? This article provides a few recommendations.
- Read and Re-Read Your Contracts
The first step in analyzing most risks, and particularly those associated with rising material costs, is to look at the document(s) that addresses which party bears that risk. In most situations, it’s the written contract between the affected parties. In the case of an owner and contractor it’s typically the prime contract. However, downstream agreements between the general contractor and subcontractors may also include risk shifting provisions that bear on these issues as well. Often, project personnel responsible for managing these issues may not even be aware of the relevant provisions in the pertinent agreement, in part because materials costs have not risen this quickly in over a decade. Therefore, a careful and thorough review of your contracts should be conducted by personnel with relevant training and experience to determine how the risk of escalating material costs are to be borne by owner, general contractor, Subcontractor, or even the vendors.
- Active Cost Monitoring (Project Meetings)
Recommendation number two can be summarized as follows: Be proactive! One of the best ways to handle this unique situation is to ensure that all project participants have the most complete and up-to-date pricing information before decisions are made. While it may sound simple, weekly, or even daily project meetings/conferences can help companies manage the process. Frequent meetings/conferences keep project staff focused on managing this risk by, among other things, keeping in touch with vendors, potentially allowing for opportunities to lock in prices early by buying out the critical material supplies as soon as possible and perhaps most importantly, shortening the decision making process. In situations where vendors and suppliers can or will only keep a quote open for short time periods, it is imperative for responsible project managers and representatives to be able to make decisions quickly with the requisite approvals needed internally.
- Preparation of Template Change Orders/Notice Letters
Regardless of the contract provisions at play, it is a good idea for companies to be aware of and plan for the preparation of proposed change orders and notice letters for increased materials costs. Again, it is important to review the relevant contract language, but it’s an equally important to prepare template change orders and letters so they are readily available and easy for the project team to finalize and send out when needed. This is especially important when it comes to notice letters because contracts may require notices be sent within very short timeframes from the discovery of the conditions giving rise to the claim or request for a change order. In those situations, template notice letters can be a life saver for the project team and especially where multiple notices need to be prepared and sent in or around the same time. Oftentimes, these template notices can also be modified and used for other unexpected conditions, including, for example, COVID-19 pandemic related issues.
- Negotiate Price Escalation Into Your Contract
Now more than ever before you should make sure that you are addressing price escalation risks in your contracts. Be creative. Consider allowing for price increases between the time the contract is signed and when material orders will generally be placed. This can protect you when material prices increase significantly after the contract is signed but before the materials are actually ordered. The better prepared and more proactive you are, the more likely that other parties will be willing to work with you to find solutions for these increased risks.
It is highly unlikely that anyone can predict with certainty when materials costs will stabilize, but the more proactive you are in dealing with this situation, the better equipped you will be to deal with its impact. Also, consider that these strategies can be modified and applied to other potentially disruptive events that can unexpectedly impact a project.