What is a contingency in residential construction: What builders need to know

If construction is stalled due to unexpected site conditions or supply chain disruptions, who’s responsible for absorbing these costs? Is it you? Thankfully, the answer is “no” if you have construction contingencies in place.

Read on to learn more about the many kinds of construction contingencies and the benefits for each. Plus, we’ll give tips on how to best use contingencies.

What is a contingency in construction?

A contingency in construction is a part of the project budget allocated for emergencies that offers businesses a backup or safety net in preparation for unexpected negative events. They provide financial padding to protect margins in the event of price changes.

In residential construction, a contingency refers to a percentage or fixed amount of money set aside to cover unanticipated costs that may arise during a project. A contingency provides an extra margin in the project budget so home builders and remodelers can keep their projects profitable when new or unexpected costs come up or prices change.

Why are construction contingencies important?

One of the biggest challenges facing builders involves balancing income and expenses on each project to ensure their overall business cash flow stays stable. Prior to putting boots on the ground, estimators put together a prediction of what materials, labor costs and subcontractor work might cost, then tack on a margin percentage to ensure money comes in.

These cost predictions come from subcontractor bids and vendor quotes but typically appear on the preliminary budget months before work begins. In the meantime, costs change and prices fluctuate, turning that prediction into a guess. Unless builders lock in prices with subcontractors and vendors, they face the risk that cost increases will eat into their margins. Cost changes on client selections could also negatively impact their margins.

Construction contingencies are important because they ensure that small, often overlooked details or unexpected issues that arise during a project don’t derail the financials.

Home builders deal with numerous details throughout every build, and occasionally they may overlook a hidden cost when writing up a construction budget. But thanks to construction contingencies, these hidden or overlooked costs don’t have to sink a project. Residential construction companies that use them in their financials have a competitive edge and can stay profitable while responding to new costs throughout a project.

Examples of construction contingencies

There are many occasions when additional costs are added to your project – having a contingency in place will absorb these expenses for you. Here are some examples of when a construction contingency plan could help you out.

Labor shortage contingency

In the construction industry where skilled labor is in high demand and also in a shortage, you need to have a contingency plan in place.There’s already a shortage of skilled workers, but if your project is in a remote area, there may be even more of a shortage. Because of this, you may need the construction contingency funds to train workers or pivot and hire new subcontractors.

Material shortage contingency

If you’re working on a project where your primary building material is either lumber or steel, it’s a good idea to have a contingency plan to cover the fluctuating price of these materials and possible supply chain delays. The plan should include finding alternate types of materials and scheduling the deliveries in advance. Your contingency will give you the cushion to adjust and consider an alternative source­, plus it’ll cover the cost difference.

Weather contingency

If you work in an area prone to severe storms, your team should create a plan for weather-related delays. Include additional costs associated with securing the site before the storm and scheduling and planning for extra labor to help clean up after the storm. You should also consider funds for replacing any building materials damaged in the storm. When it does hit, the team will be prepared to quickly execute the plan and avoid additional costs.

Top 5 benefits of using construction contingencies

Using contingency plans provides many benefits for builders beyond just saving you money. Here are the top five reasons why you should protect your business with construction contingencies.

1. Protects the project budget

By setting aside funds specifically for contingencies, builders will avoid borrowing funds from other projects or taking out loans to cover these additional costs. For example, if there’s an unexpected issue with the foundation of a project that requires additional excavation work and materials, the set-aside funds would cover this expense. All unplanned expenses will be accounted for, and your budget will remain intact.

2. Reduces financial risk

Contingencies act as safety nets within your overall construction payment strategy. Without this protection, unexpected issues can jeopardize your financial stability and lead to project delays and possibly project failure. Let’s say you’re working on a remodel and you uncover extensive water damage in the basement ceiling that needs to be repaired before the project can go any further. Without a contingency in place, you would absorb this cost and the project would go over budget.

3. Provides peace of mind

Having these protections in place will allow builders a strong level of comfort. Your project manager can focus on delivering high-quality work without worrying about possible setbacks. If you’re working in an area prone to natural disasters, and a severe storm damages your building materials, you might experience timeline delays and additional expenses. But if you have a contingency in place that protects you against weather-related setbacks, you can move on with the project without a significant financial blow.

4. Improves project planning

It’s important to always think ahead about potential project challenges.Including contingencies in the project budget and timeline will force your crew to plan ahead and improve your construction project efficiency. As we know, proper planning prevents poor performance. This advice relates to obtaining government permits – plan for setbacks by including a contingency in the project timeline that covers permit delays.

5. Encourages proactive problem-solving

Because of your project planning, builders will be better positioned to solve issues as they arise. Anticipating bumps in the road and setting aside resources to address them will minimize delays and cost overruns. Let’s say your project manager runs into significant mold growth that must be mitigated before any more work can be done. If you have a contingency setup for any unforeseen repairs, you’ll have the resources to quickly address and clean up the mold and get your project back on track. 

What are the different types of construction contingencies?

There are three different types of construction contingencies: Contractor contingencies, owner contingencies and design contingencies. 

Contractor contingency

In a contractor contingency, the builder takes financial responsibility for any additional money spent on a project. This type of contingency usually requires construction companies to reduce their profit margins since they take on additional costs.

Owner contingency

In an owner contingency, the client bears the brunt of additional costs beyond the project’s original scope of work. Owner contingencies are typically used in conjunction with fixed price contracts when a project’s scope and budget are clearly defined. In a fixed price contract, money can’t be spent beyond a defined threshold.

Design contingency

In a design contingency, the client bears the burden of additional cost. This contingency is used for unforeseen costs during the design phase, when changes in scope are often initiated by the client.

How do home builders and remodelers use construction contingencies?

Residential construction contractors implement contingencies in their projects using manual, software or integrated software methods. 

Manual methods

Home builders and remodelers usually allocate between 5% and 10% of a project budget for a construction contingency. This amount creates enough breathing room for unexpected costs. Anyone tracking estimates and costs manually will calculate a contingency percentage on top of all costs before profit margins are applied. Whether they’re done on paper or calculated by hand, these methods offer familiar and accessible estimating options that get budgets and proposals in the hands of clients. Any price negotiations or recalculations, however, require careful tracking and risk human error.

Software methods

Spreadsheet software, like Google Sheets and Microsoft Excel, helps general contractors manage construction contingencies through formulas and digital files that reduce human error and automate calculations. These programs require a very hands-on approach, taking several iterations to get all elements working together.

Builders also use accounting software, such as QuickBooks, for tracking project financials. These accounting systems excel at reporting on income and expenses going toward a pre-set contingency budget but are limited when it comes to applying markups. While these tools offer a digital experience that prevents the paper shuffle, they struggle to cover the financial shifts from cost estimate to contract price to constant budget adjustments.

Integrated software methods

An integrated software method, like Buildertrend, brings all your construction management needs together in one place. Using a program that includes everything you need has many advantages over a standalone software program such as QuickBooks.

Your accounting, estimating, scheduling and job costing are all incorporated onto a single platform. This streamlines your process because the elements work together and adjust as your construction project shifts and changes. Another pro of the integrated method is there’s no risk of human error.  

Tips for using construction contingencies

Here are some tips to help you effectively use construction contingencies.

1. Plan for contingencies

Take into account all risks and potential uncertainties that could impact your project. Consider the most likely contingencies and allocate funds to address those needs. Create a step-by-step plan that you’ll implement in the event that a contingency is needed.

2. Allocate contingencies wisely

Set aside a well-researched contingency amount, typically between 5% and 10% of the overall project budget. Allocate funds to cover the most likely and expensive contingencies first and then assign the remaining funds to cover the remaining events and risks. It’s important not to allocate too much or too little – either case can have negative consequences.

3. Monitor contingencies

Your project manager should regularly track your contingency funds to make sure they’re being used effectively. Keep detailed records and adjust your funds based on actual contingencies as the project moves along.

4. Use contingencies as a last resort

Only use these funds when all other options have been considered. You never know when an issue may arise later in the project and the funds will be truly needed. It’s important to get approval when using funds for any significant changes – this will help maintain a trusting client relationship.  

5. Document the use of contingencies

Record expenses or delays covered by the contingency fund. Plus, update any impacts these changes have on the project scope and timeline.

6. Reevaluate contingencies

Throughout the project, reevaluate your plan and total budget as contingencies are used. If a major unexpected event or risk pops up during the project, you’ll need to make adjustments.

Integrated construction project management software

With Buildertrend on your side, you can manage the contingency details that suit the project and client – and track the budget and timeline. Choose the construction management program that’s reliable and automates the process of protecting your construction business for you.

You’re going to be busy adjusting when those unexpected changes occur, so let us take on the administration part… it’s a lot to keep track of.

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