When COVID-19 slammed the breaks on the U.S. economy and imposed government mandated restrictions on business activity, construction activity coast to coast suddenly slowed and, in some cases, stopped. The vast ecosystem of stakeholders—from contractors, suppliers and workers to the investors that fund the projects—was disrupted, causing a ripple effect that blanketed the country.
With most construction projects resuming in this changed landscape , developers have been given an opportunity to emerge from the crisis —but the rules have changed. New risks have emerged that could affect project economics, and new considerations must be made. As you continue to navigate the current environment during a time that’s widely referred to as “the new normal,” be mindful of the following pitfalls that may present significant risk to your project.
- Insolvency of a contractor: Perform due diligence on contractors and subcontractors to reduce the risk that a selected contractor will disrupt the project due to their financial condition or possible insolvency. Replacing a contractor or trade midstream will significantly alter project budgets and schedules. Additionally, if the contractor or subcontractor becomes insolvent, material purchased/billed and stored at the general contractor’s or subcontractor’s site may be difficult to obtain or validate as to its ownership. What’s more, any front-loaded costs will likely not be recoverable, and retainage will be inadequate to mitigate any loss.
- Delays: Be sure to properly monitor project delays. Failure to do so may result in excess general conditions paid to the contractor, incorrect calculations of liquidated damages, and unavoidable extensions to the project timeline.
- Considerations of the current climate: Remember, nothing is as it was before. Be sure your new construction contracts reflect the current environment and circumstances. For example, you should give consideration to the following:
a. Additional labor and time required to disinfect construction equipment
b. Potential infections that could result in a temporary shutdown
c. Policies related to sanitization of construction sites
d. Force majeure clauses
e. Clear and detailed documentation requirements for payment applications
f. Potential costs associated with redesigned floor plans that accommodate social distancing
- Material substitutions: Insist on proper documentation and approval protocols to handle material substitutions. That is, make sure the original materials cost is removed completely from the project and that the replacement material fits all the project requirements.
- Payment timing: Avoid paying your general contractor before receiving proper evidence for expenditures (especially on long-term, multi-year projects). Prematurely paying your general contractor may result in a transfer of funds to the contractor before funds for expenditures have been disbursed. Also be aware that contractors may attempt to front-end load their invoices. If a party defaults altogether, you’ll be faced with increased project losses.
- Lien waivers: Validate subcontractors’ unconditional lien waivers before releasing payment. Not doing so will preclude the owner from identifying instances when the general contractor has failed to pay its subcontractors, which may ultimately result in project delays and liens on the property.
Overhead Costs and Labor
- Overhead and burden: Be sure your overhead costs and burden rates have been appropriately adjusted for the current economic landscape.
- Layoffs: Be aware of key personnel layoffs by your general contractors or subcontractors, especially if the award was contingent on an identified list of dedicated personnel. A change in personnel usually requires a learning curve of some sort, which will likely result in longer project timelines and higher project expenses.
- Decreased general contractor labor costs: Similarly, keep your finger on the pulse of your contractors’ personnel changes that reduce labor costs—savings that could be passed along to you.
- Skills that match the function: In some instances, contractors allocate higher-skilled labor to perform lower-skilled jobs without the owner’s prior approval, which almost always translates to higher project costs.
- Lump-sum contracts: You’ll want your general contractor to bill general conditions based on a percentage of completion, not on the timeframe of the anticipated project—or you may end up with accelerated, premature payments.
- Cost type contracts: General conditions should be billed based on actual costs vs. a straight-line amortization of a fixed amount price to avoid the potential for accelerated payments of general conditions during work stoppage.
- Discounts and abatements: Be wary of discounts and abatements obtained by the general contractor from its vendors that are not passed along to you, which would be a violation of the contract terms.
There are many new risks to address for your construction projects in today’s world. DLA’s construction audit experts can help you identify and stay ahead of these risks.
DLA has performed hundreds of development and redevelopment project audits, ranging in size from $2 million to $3 billion. Our established policies, procedures, and controls have been implemented successfully for many of the largest developers in the U.S. Backed by extensive on-site construction experience, our approach and tools are continually refined to address current and emerging trends.
Phil Ramacca, CPA
President & COO
Errol Labosky, CPA
David Landau, CPA, CVA
Founder & CEO
Internal Audit Practice Leader
Jacob Goldman, CPA
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