Controlling the Cost of High-Value Residential Construction The Dream and the Nightmare

This is the first in a series of articles offered by ResX, PC on controlling the cost of High-Value Residential Construction Projects. This series is intended to help the close personal advisors to high net worth clients (e.g., attorneys, accountants, and financial advisors), understand the risks their clients face when building a high-value residence and most importantly, how to mitigate these risks. Because, if a dream project turns into a nightmare, your client relationship may be irreparably harmed.

A high-value residential construction project (the “Project”) is often an owner’s (“Owner’s”) declaration to the world of his/her success. It will be a one of a kind design, with personal meaning, and special high quality features. The Project will be an entirely new building or a major renovation of an iconic home and will likely cost in excess of $3.0 million.

The challenge for the Owner of a high-value residential construction project is that almost all of these projects are billed using the cost-plus-fee approach. Hospitals, universities, and utilities never embark on a cost-plus contract without first having secured the required expertise to manage a cost-plus project. On the other hand, Owners of high-value residential construction projects generally engage in cost-plus contracts without this expertise.

The conventional approach to building a high-value residence is to hire a designer, develop a schematic design, find a contractor that is experienced in residential construction, and sign the cost-plus construction contract that the contractor proposes. Owners will engage in this process, even knowing the risks, because of the personal drive to build a dream house, the assumption that the conventional approach is the only option, and delusional optimism.

Unfortunately, the conventional approach to building high-value residential homes generally results in a Project that costs more and takes longer than originally planned. There are two fundamental reasons for this performance shortfall:

1. Typical residential home builders lack the ability, systems, and incentives to manage the Project:
   1. Project management will not focus on cost control
   2. The subcontractors will not be competitively bid
   3. Record keeping will be inadequate
2. Owners of high-value residential construction projects make decisions during the early stages and throughout the Project that are not in their best interest.
   1. The contract will favor the contractor
   2. The design will not be 100% complete
   3. The Owner will make changes
   4. The Owner will not be intimately involved in overseeing the Project

All of characteristics conspire to turn the Owner’s dream into a nightmare. The Project begins with a honeymoon period that continues until one or all of the following occurs that causes the Owner to lose trust in the contractor.

1. Unplanned cost or unanticipated delay
2. Quality problems
3. Owner questions are not answered because the contractor lacks adequate records

To minimize the risk of the dream turning into a nightmare, the Owner must establish certain rules for the contractor to follow if the contractor is to be engaged. These rules are critical and not difficult for the contractor to follow:

1. Define the cost of work that will be billable
2. Define the monthly billing procedures with regard to:
   1. Pay Application forms
   2. Submittal of lien waivers
   3. Submittal of cost back-up documentation
   4. Submittal of Project status report
3. Define the change order procedures
4. Define minimum required field records
5. Define bidding procedures for major trades (e.g., mechanical, electrical, plumbing)
6. Define records retention requirements and audit rights

An experienced construction attorney can memorialize these rules in a two page contract rider that the Owner can add to the contract proposed by the contractor. Then, during the course of the Project an experienced construction auditor can receive and approve the contractor’s monthly billing, as well as report to the Owner on cost and schedule progress.

Future articles in this series on Controlling the Cost of High-Value Residential Construction will address in greater detail the rules listed above, the procedures that should be followed during the course of a high-value residential construction project, and other related topics.

ResX, PC (“ResX”) is a full service forensic accounting firm serving clients throughout the United States with expertise in accounting, business valuation, and fraud investigations. Over the years we have developed specialized expertise in the field of construction cost control and construction project auditing.