Contractors operate with low profit margins as it is, so absorbing the increased cost of materials and labor is usually not an option.
There are three main ways contractors can effectively deal with construction cost increases: financing building material purchases, adding a margin to their estimates, or including an escalation clause in the contract.
1. Protect your Lien Rights
Protecting your lien rights is one of the most critical steps in protecting your right to payment for what has been delivered to a job site.
Most states base the amount allowed on a lien on the true and fair value of the material and labor delivered to the job site, so even if your contracts list pre-tariff pricing, there may be recourse.
Make sure to check our state-by-state guide Here, and make sure to understand if you are in a state that requires an amended preliminary notice if costs increase substantially.
2. Increase your margins
Contractors can raise their prices to their customers in order to offset potential cost increases. How much to raise prices depends on the length of the project and the materials you are using.
One problem with raising margins: There’s no guarantee that prices won’t increase more during the duration of the project. You may be limited in your ability to recapture that lost income.
And with intense competition for projects, contractors who attempt to cover potential cost increases in their price may find themselves losing bids. Other contractors may not be keeping pace with pricing changes.
That’s not necessarily a bad thing. Competing on price is almost always a lose-lose proposition. Taking a low- or no-margin job may be an effective way to get your foot in the door with a GC or developer — but it’s not an effective long-term strategy. Instead, focus on the value that your company brings to the job.
3. Include an escalation clause
An escalation clause in the contract allows contractors to recoup costs caused by price increases. The clause usually stipulates a percentage increase that costs must exceed before the clause kicks in.
For example, an escalation clause may say that, if material or labor costs increase more than 3% during the project, the contractor has the right to request additional funds from the owner for the increase.
These clauses protect contractors and owners alike. Without an escalation clause, contractors will raise their bids to cover potential price increases. With an escalation clause, contractors can provide a more competitive estimate without additional margin for risk.
Watch the webinar: How to use contract clauses to defend against material price swings
The rise in construction costs is expected to continue
All contractors operate on credit, effectively financing their customer’s projects with their own money. An increase in construction costs means higher credit risk. Don’t forget that problems with payment add costs to the job as well.
Even if you double your margins, a missed payment can erase any potential gains you might have earned. Make sure you are also taking steps to protect your payment and get paid faster on every project.
Concerned about how you can protect your bottom line and speed up slow payments as a result of sharply rising costs? Request a call Here from one of our payment experts today.