What can a board do if its building is faced with extensive capital work while recovering from the real estate slump of the early 1990s? Assessments are unpopular and reserves are low. There's a desire to have construction operations completed as quickly as possible, but an aversion to parting with too much money at one time. One way to solve this dilemna is to phase in the capital programs over an extended time. Undertaking construction in distinct stages offers many advantages as well as potential pitfalls. Armed with the proper information, however, the board can organize the building's construction into phases that best suit their purposes.
Examining the Project
Capital improvements generally get their first moment of reckoning when the board sees the cost estimate for the work. If there's going to be a significant amount taken from the capital reserve fund, or even a shareholder assessment, there will always be at least one board member who asks, Do we really have to do all of this? The answer requires an examination of the nature of the work and whether some aspects can indeed be put off until a later date. Architects and engineers are often brought in to advise on a particular item only to find that it is a symptom of a more widespread problem. For example, a board may know of water damage in certain apartments, while a survey reveals that a more extensive area is affected.
Architects' and engineers' reports often set out their recommendations in terms of priorities. Items are grouped into those needing immediate attention, those that should be completed within the next year or so, and those that can wait somewhat longer. A three-phase program is the obvious result, but this may not be the best solution. Financial commitment, cash flow, disruption, delay, competitiveness and other factors need to be considered as well, and this should be done before contract documents are prepared.
Stretching out the work over several phases allows cash flow requirements to be evened out over an extended period. It also enables a board to evaluate the effectiveness of its architect's or engineer's recommendations. This can be done by having the first phase cover only a small portion of the work. This method can also help keep disruption to a minimum.
Single or Sequential Projects
Capital improvements can be phased two ways: The board can prepare a single contract and have one contractor responsible for providing the entire scope of work; or, the work can be broken up into several sub-projects that can be done in sequence by the same or various contractors.
The former method is best when the board wants to have consistent work teams or when the project involves specialty equipment that can be obtained from a single supplier. However, this method commits the board to paying the entire dollar value of the project over a short period of time. Under the latter method, the board commits to the dollar value of its capital program one project at a time and can spread payments out over a longer timespan.
Construction is no different from other industries in that it involves economies of scale. The more you buy at one time, the cheaper the project is per unit. Piecemeal purchase of construction services can quickly become uneconomical. This is not only because the contractor is purchasing smaller quantiti ffb es, but also because of all the set-up costs involved in each job, including permits, insurance, fencing, tools, scaffolding and other pre-construction items.
These expenses, known in the contracting industry as mobilization, are more related to the nature of the building than the size of the project. If the project is large, mobilization will be a relatively small percentage of the total cost. If the same work is spread among several sub-projects with different contractors, mobilization becomes a relatively large percentage of the overall cost. This cost can be reduced if the same contractor is allowed to bid on all of the sub-projects. If the contractor can begin work promptly, from one project to the next, mobilization need only cover the additional pre-construction costs needed for the next project. This is one reason why an incumbent contractor enjoys a competitive advantage.
A series of separate sub-projects covering smaller units of work is best when the board is concerned about cash flow and is unable to commit to the entire capital program at once. Or if the board wishes to undertake some work on an accelerated basis while the architect or engineer designs the remainder. Another scenario is if the board requires completion of part of the work by a certain date, for example to clear a building department violation.
However, this method is not suitable if two or more of these projects will require dealing with the same supplier or manufacturer. Boards generally want to stick to the same product in their capital program. For example, most buildings want identical passenger elevator cabs. These will only be obtainable from the same supplier. If a board can't commit to the replacement of all its elevator cabs at once, a deal needs to be made with the supplier locking it in to a particular price range. If these kinds of arrangements are not made, boards could find themselves paying inflated prices for the same product in succeeding phases.
Working Out the Timing
Determining the separate phases for a capital improvement is best worked out with an architect or engineer at the time the contract documents are being prepared. The board may wish to hire a construction professional for help with this. Though all projects are unique in nature, phasing decisions do share some common elements. If the project falls into naturally separate units such as separate buildings, separate roof levels, separate wall facades, separate apartments, etc., and the nature of the work is such that a board will not get locked in with any particular product supplier or manufacturerand the board doesn't have the money right now to commit to the whole projectthen consider separate, sequential sub-projects, each with its own contract.
On the other hand, if the project requires installation of a proprietary product or the board needs to realize maximum economy on the work overall, or there is a need to keep an experienced project team together, then consider a single contract covering the entire project with phased completion and hand-over.
Most boards want their capital improvements to be completed quickly, but to be given an extended period in which to pay for them. They want disruption kept to a minimum, whereas contractors offer savings if they can avoid piecemeal work. The work may involve a single supplier, yet the board would like its bids to be competitive. And economy is greatest with larger projects, only the board does not want to be overwhelmed with too much construction at once. Fortunately, practical compromises between these competing goals are possible. A construction professional can help the board in coming up with the best combination of priorities.
Boards might also obtain their project funding stream from another source. A company specializing in construction finance, or even the contractor itself, may lend the money. The board will need to provide security for the loan, and will most likely give up some aspects of control as well. Boards should only consider obtaining financing from the con 921 tractor if he has already established a good track record of undertaking similar work in other buildings.
Mr. Skilling is a Manhattan-based professional engineer and independent consultant specializing in capital program management.
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