In real estate development, setting a budget is one of the most critical things you have to do. A realistic budget is one of the first steps in setting up your project for success. On the flip side, a poorly thought-out budget is one way to tank a development project – or end up with much less ROI than you expected.
Whether you’re new to real estate development or have a few projects under your belt, budgeting is something that can always benefit from expert advice. Developers, architects, construction contractors can all give you valuable input as you’re figuring out your budget and financing.
Construction costs have become especially volatile lately – you may have already read about it, or you can click here for our recent blog post that discusses lumber pricing. It’s important for your development, design, and construction teams to work closely together to figure out how to proceed given the latest price increases and material shortages.
So, how should you get started with budgeting? The biggest thing is to talk openly with your development team about your expectations for the project’s performance. Share your business plan, your expectations in terms of ROI, your goals, what you think your operating costs will be – all of it. And listen to what they have to say about materials, scheduling, and design tips that can help your project.
And if there are aspects of the financials that you’re unsure about, your developer can help with that. Commercial real estate developers are a valuable resource when you’re figuring out how to make the financial piece of your project work – it’s a huge part of what they do, so they’re accustomed to running different scenarios and have strong knowledge of the local market.
Here are a few other tips for you to consider when you’re building a budget, and also some ways to help keep that budget on track throughout the project.
Choose an architect who specializes in the type of building you’re building or renovating
They’ll have a much better idea of what you can afford and what things cost, since they do similar projects often. You don’t want an architect who will overdesign or select materials that don’t work within your budget, only to have to go back and redesign the project.
Because they’re so familiar with the building type and the trends in the industry, savvy architects will be able to help you decide what’s a “must have,” which features and functions are important, and which you can skip. They can also give you advice on which trends are important to pay attention to, and which ones appear to be short-lived and therefore not necessary to include in the design.
Have a builder on your team right from the start
Architects can develop cost estimates for you, but contractors have better knowledge of the market (and its frequent changes) since they pretty much live in the world of material and labor pricing on a daily basis.
Having a contractor on board can help give you almost real-time pricing information during the design phase of your project. So when you’re making decisions about the building, you’ll know quickly how those decisions will affect the construction cost because the contractor can price them out for you. There’s no better way to make budget-conscious decisions!
Keep in mind that the builder’s cost estimates will be less accurate early on when the design is mostly conceptual, and will be refined later as more of the details get solidified. So you’ll need to be flexible when it comes to design decisions. Something that you agreed on early on in the process may eventually prove to be too expensive, so try to avoid getting too emotionally attached to the various elements of the design.
If your project is looking like it’s over budget, your team will want to engage in value engineering – and you’ll want to have a contractor’s input for that. Value engineering doesn’t just mean cutting things out of the project haphazardly. It involves evaluating the project as a whole to balance functionality and costs.
So, for example, if you’re building a restaurant, cutting a bunch of the kitchen equipment would save a lot of money – but it would also make your restaurant non-functional. So the value engineering effort would focus on other things that can be re-evaluated and redesigned to save money, while keeping the full functionality that you need.
Avoid “scope creep”
You and your development team will need to communicate in very clear terms (and in writing, of course) what the scope of your project is, what they’ll be handling for you, and what you’re responsible for.
And when it’s time to bring on the design and construction teams, it’s just as important to specifically outline what each firm is doing. It protects you by making sure that everything is covered, helps you know exactly how much you’ll be paying each firm, and it protects the design & construction firms from having to do a bunch of unexpected work that wasn’t included in their fee.
Each firm’s contract should clearly state the scope and should also list specific things that are excluded from the scope if applicable. When there are changes to someone’s scope, make sure those are documented. And if something comes up that needs to be done but is outside of someone’s scope, get a price quote and authorize them to proceed first, so that you aren’t caught by surprise later when the work is complete and you didn’t know how much it would cost.
Communicate regularly with your development team
We’d recommend a weekly meeting or check-in at minimum – and during construction it may even need to be more frequent. Things move very fast during construction, and a lot of times decisions need to be made as soon as possible in order to avoid delaying a bunch of trades and activities.
Open communication with your development team is so important! It’s the only way the team can help manage the budget, and helps everything run more smoothly. Don’t be tempted to hide your “real” budget because you’re afraid they’ll spend it all. The reputable professionals on your team want your project to be successful, and will work on your behalf to make that happen.
Include contingency funds in your budget
A contingency in your budget is basically a rainy day fund – it’s money that’s set aside to cover unexpected expenses, to help keep your project from going off the rails when something comes up that you didn’t anticipate.
What kinds of things might a contingency fund cover?
In the design phase, a contingency fund might cover inaccurate information (like if everyone was told that the building’s foundation is in good shape but a later inspection finds problems with it, and now the design needs to correct those issues). It could also cover added costs if you decide to upgrade some of the exterior materials on your building based on market / competitor research.
During construction, a contingency fund covers unforeseen costs. Don’t be surprised when there are things that come up unexpectedly – it happens on every project.
In our experience, a team approach to budgeting is best. Talk openly with your developer about the issues we’ve outlined here, and you’ll be well on your way to starting your project on the right track. Also remember to remain flexible and keep your end goal in mind. Even when setbacks happen, a good team can adjust to make sure your project moves forward and meets your goals.