Risk management is the name of the game in construction. Including a construction contingency in your budget is the first step to protecting yourself against any unforeseen risks. Remember: Risks equal costs, and the money needs to come from somewhere.
“Hoping for the best, prepared for the worst, and unsurprised by anything in between”
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What is Construction Contingency?
A construction contingency is an amount of money set aside to cover any unexpected costs that can arise throughout a construction project. This money is on reserve and is not allocated to any specific area of work. Essentially, the contingency acts as insurance against other, unforeseen costs.
Determining the amount of contingency is a balancing act. On the one hand, you want to have enough contingency funds to cover any uncertainties. On the other hand, you need enough cash on hand to keep construction going. Most projects will use a rate of around 5-10% of the total budget for contingencies.
Don’t Confuse a Contingency With an Allowance!
Types of Construction Contingencies
There are two main types of construction contingency funds: contractor contingency and owner contingency.
A contractor contingency is an amount built into the contractor’s anticipated price for the project to account for various risk factors that cannot otherwise be accounted for in a schedule of values. This money is set aside to account for any errors that occur on behalf of the contractor. Accordingly, contractors consider these funds spent money. Building this extra funding into your estimate is the contractor accepting the fact that unpredictable costs are all part of the construction biz.
An owner’s reserve is an amount set aside for additions or modifications of the scope of the work. These types of contingencies are used mainly in guaranteed maximum price (GMP) contracts. Changes and mistakes are not always the contractor’s fault. Any changes that are not included in the initial bid will have to be paid by the owner funded contingency. Incomplete plans or owner directed changes are the leading causes of dipping into an owner contingency fund.
Creating a Construction Contingency Budget
When encountering a construction contingency clause in your contract, it is essential to keep an eye out for a few things. First, it should detail both the owner’s contingency and the contractor’s contingency. They should list any and all predetermined costs that the contingency should be used for. The list could include anything from incomplete designs, construction delays, substitute subcontractors, price increases, and any other number of unexpected costs. This is generally referred to as the contingency budget.
The contingency budget should also include a well-drafted process of how to access contingency funds. It’s best to have a detailed procedure concerning notices, paperwork, and approvals. The contingency budget should also prepare for unspent portions of the contingency fund. Are the remaining funds shared among the contractor or subs as an incentive? Or does the money revert to the one funding the contingency? It’s a good idea to clarify how the contingency funds will be managed from the jump. Otherwise, deciding how to manage unspent contingencies could create some headaches.
Is Contingency the Same as Retainage?
A construction contingency fund is not the same as retainage, but the concepts are similar. Both retainage and contingency provide what are essentially “emergency” funds. When something on the project goes awry and costs some extra $, paying to fix the issue may come from the contingency fund, or it may come from the retainage being withheld from the contractor or subcontractor who created the issue. Plus retainage and contingency both represent about 5-10% of the construction price.
However, retainage represents an amount of the contract price that has been earned but remains withheld. It serves a purpose, but at the end of the day, it’s payment owed that’s being withheld. Construction contingency, on the other hand, is actual inflation of the contract price to plan for the unexpected. That, or it’s funding set aside by the owner for the unexpected issues.
It might sound a bit like semantics, but that’s a huge, fundamental difference between the two. Retainage represents dollars earned and unpaid – and that amount could be the difference between a construction business turning a healthy profit or losing money on a job. Contingency isn’t owed to anyone, and it could even turn into a positive if the contingency fund goes unused and gets dispersed to project participants.