“There are a lot of unknown variables at the start of a project that must be accounted for in the budget process. Rather than being surprised every time something new comes up, it’s important to consider some historical data about what sorts of things are likely to happen and what can be done to prepare for them,” says Richard Vermeulen, a principal and lead economist with Vermeulens Cost Consultants, a Boston-based firm with a Toronto head office that has provided construction estimating services for more than $14 billion worth of lab facility construction across North America.

The historically established rate of average price escalation over the past 20 years has been approximately 3.5 percent, according to Vermeulen. This trend was outpaced in the late 1990s and early 2000s due to accelerated market demand and reduced interest rates. There was a notable drop in the wake of 9/11 and a brief recession occurred causing prices to fall back to the trend line. The industry has since recovered and building costs for the past few years have consistently exceeded the 3.5 percent trend.

Benchmarking the Basics

Establishing accurate cost benchmarks is a critical part of the budget planning process. While there are numerous industry-specific publications that provide benchmarking data with generic cost-per-square footage ranges that are very useful, none of the buildings used to develop these figures are identical.

“Every facility is unique. You can’t take data out of context and simply apply it to a new building. It is crucial that the project histories of benchmark facilities are well known. It doesn’t do any good to use a square footage cost number from an unfamiliar project and then learn later on that 30 percent of the building was shelled for future build out,” says Vermeulen.

Aside from program elements, other important elements for establishing benchmarks include building systems, structure, enclosure, and mechanical systems. Ideally, benchmark data is derived from recently completed projects with similar programs built in the same region.

To understand benchmark data more accurately, Vermeulens Cost Consultants and Ellenzweig, a Boston-based architectural firm, analyzed the budgeting and procurement processes of four recently completed facilities. Three of the four case studies were academic projects and one was a research facility. The first was a $135-million, 430,000-sf interdisciplinary science building at the University of Chicago. The second was the $50-million, 146,500-sf Eisai Research Institute, a pharmaceutical R&D facility in Massachusetts. The third one was a $44-million, 110,000-sf life sciences research building at the University of Pennsylvania with a number of specialized elements such as plant growth, vivarium space, and aquatics. The fourth was a $76-million, 235,000-sf life sciences research and teaching complex built for Syracuse University that was attached to an existing building.

Contingency Planning

Contingency planning is also an integral part of the cost estimation process, but it is critical that individual contingencies are clearly understood at the outset of a project. Standard variables include design contingency, escalation contingency, and construction management (CM) contingency. There are also owner construction and owner design contingencies.

Design contingency is a variable that accommodates changes in the design phase. This figure typically starts high—at approximately 10 to 15 percent—and reduces to zero as the project gets closer to construction.

“If you plan for 100 fume hoods in the budget, there may be a slight change to that as things progress, but the design contingency isn’t intended to cover 200 fume hoods,” says Vermeulen.

Escalation contingency is divide into two categories: inflation and bidding. Inflation is estimated at 4 to 6 percent in accord with the historically established 3.5 percent rate of increase in the cost of materials and labor between the start of planning and the beginning of construction.

“This is consistent with consumer price index and Federal Reserve inflation targets and recent construction industry trends, so it is a good baseline to understand inflation from,” Vermeulen says.

Bidding contingency, according to Vermeulen, is designed to absorb volatility in the marketplace. The bidding contingency can be plus or minus 10 percent depending on the nature of the market. The CM contingency—typically 3 to 5 percent—is included to offset errors in scope assumptions by the construction manager and is typically defined within the construction budget. In the event a CM process is not used, this number is zero because this risk is absorbed in the lump sum bid.

The owner construction contingency (approximately four percent) covers change orders that arise during construction, regulatory changes in the field of study, and imperfections in documentation. The owner design contingency (approximately 3 to 5 percent) is included in the initial project cost to give the owner flexibility to make changes in project scope during the design stages, add program enrichments, and change soft costs.

Timing is Everything

Due to the volatile nature of the market, timing has a significant impact on the cost of a project. For example, planning for the University of Chicago’s science building began in the late 1990s at the peak of increased market activity and was priced accordingly. After the design development estimate was issued, the University requested a Guaranteed Maximum Price (GMP) bid from the construction manager with the intention of starting construction early and beating the inflation time line. In the two months it took to prepare the GMP, the construction manager raised the final number by $20 million—well above what the University could afford even after increasing the project budget. As a result, the schedule for construction was delayed five months to let the market cool. In that time period the University initiated a competitive GMP bidding process and had three construction managers providing pricing options, which ultimately allowed the University to negotiate a considerable amount of savings from a position of strength. Additionally, the price of steel at the design development phase of the project was approximately $2,200 a ton, but by the time the contract documents were developed the price had dropped to $2,100.

“A $20 million difference is obviously a huge delta, but it wasn’t entirely a result of the change in market conditions. In this case, it was also the change in procurement process,” says Vermeulen.

Procurement Options

Different procurement options have varying impacts on price and level of service. Vermeulens estimates a 10 to 15 percent premium in price levels when the CM assumes the risk of final costs and the owner negotiates a contract directly with a construction manager, as opposed to a lump-sum bid model where pre-qualified general contractors submit bids for the complete scope of work.

When the CM assumes responsibility in a negotiated contract, the end costs can vary depending on completeness of documents, fast-tracking and scheduling, the relationship between the owner and the CM, and the cost control process.

Under the CM RFP model, proponents provide an estimate of costs and commit to general requirements and fee at the schematic design stage. Vermeulen estimates a 5 to 10 percent cost premium under this model as compared to the lump-sum bid. With a CM “modified bid” approach, proponents provide the owner with a GMP based on completed construction documents. This model carries a price premium of approximately five percent.

“Ultimately, the procurement choice boils down to a balance of cost versus levels of
quality and service. The modified CM process used by the University of Chicago provided a good level of service at an acceptable cost, while the Eisai project and the University of Pennsylvania were lump-sum bids that provided lower costs with a corresponding decrease in service,” says Vermeulen.

Case Studies in Cost Control

In the selected case studies, specialized laboratory and animal spaces were well above average pricing, registering between $600 and $800 per square foot.

“Part of the reason is that auxiliary space (corridors, mechanical spaces, wall thicknesses, and shafts) is all priced at a marginal rate because the costs associated with these spaces are additive to the net program” says Vermeulen.

When the Syracuse project estimates reached double the original budget amount, facility planners looked to see what could be done. Programs were categorized according to major space components and dollars per square foot were assigned to each of those areas.

“Initially, they looked for functions that could be doubled up by doing things like sharing teaching spaces instead of having one instructional space for every subject type,” says Vermeulen.

More expensive types of spaces were targeted next. Animal and greenhouse facilities were only partially built out, but shelled for future implementation.

“The greenhouse space was very expensive so they built what was immediately necessary and left space for future connections. This made significant progress in terms of reducing the project cost disproportionate to the reduction in square footage,” says Vermeulen.

The intensive value engineering process reduced final project costs significantly, but this was also accompanied by a reduction in the total size of the building.

“The ratio of assigned dollars per square foot to net space was reduced, but the building efficiency did not change. None of the mechanical elements, shafts, or corridor spaces were expected to yield cost savings. They simply reduced in price with the proportion of the building,” says Vermeulen.

Conclusions and Future Conditions

The best way to predict and control costs, according to Vermeulen, is to start with a highly informed process for budget formation that is facilitated by experienced professionals and built on known benchmarks for both program and support systems.

Clearly defined budget contingencies are also critical to mitigating unexpected costs. Strategically managed competitive bidding during the procurement stage can also help put the customer in a stronger negotiating position.

“One of the most important things to remember is the fluctuating nature of the market and how it relates to long term trends. The Federal Reserve has targeted a three percent inflation rate for the consumer price index. That helps establish a trend line for the construction industry of about 3.5 percent per year. As long as the Fed reacts to control that rate of escalation, there should be fairly orderly economic progress as we move forward and fluctuations will eventually return to the trend line,” says Vermeulen.

By Johnathon Allen