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The commercial real estate sector looks to be on course for a challenging year in 2023.
The Federal Reserve made six interest rate increases in 2022 to fight skyrocketing inflation, a strategy analysts believe has pushed the housing market into recession. The supply chain bottlenecks and labor shortages that have affected the field this year will still be around in January. Those difficulties will make real estate development more complicated and expensive next year.
Nevertheless, project managers will still be responsible for commanding budgets and schedules. But you can use procedures, techniques, and tools to keep the train on the tracks, even in a challenging economic environment.
Prepare for High Construction Costs & Supply Chain Hiccups
First, the bad news; market analysts believe that high construction expenses and supply chain hiccups will be multiyear headwinds for commercial real estate.
This summer, CBRE predicted construction expenses would rise by 14.1% annually in 2022, the highest year-over-year increase since 2007. The firm identified the coronavirus pandemic as the root of the problem. COVID-19 prompted widespread regional lockdowns that temporarily reduced manufacturing output and created a global semiconductor shortage that spilled out into hundreds of other sectors. Russia’s invasion of Ukraine this February exacerbated the supply chain bottlenecks, drove up soft commodity prices, and disrupted freight transportation. On top of all that, the construction industry is dealing with a major worker shortfall.
Since those issues are ongoing, CBRE expects construction costs will keep climbing in 2023, rising by 4.3%. But here’s the good news; project managers can mitigate the impact those problems will have on their projects.
Real estate attorney Michael Kupin explained that development firms could lower their construction and supply chain risks by eliminating contract vagueness. He argued companies should carefully outline every vendor’s responsibility for material price hikes and schedule delays. The idea isn’t to try and make projects more cost-effective by lowering your partner’s profit margins. It’s about defining the parameters of the project’s change orders before development starts, so you’ll have a much clearer picture of your potential exposures.
Kupin also suggested that firms require their partners to stockpile key building materials as far in advance as possible. Since the pandemic began, lead times for items like steel joists, electrical switchgear, and precast concrete have doubled or tripled. Purchasing supplies in bulk before the shovels hit the ground is a bold move. But it can be highly effective at mitigating the impact of supply chain snarls.
Creating caches of materials will necessitate close coordination and consistent communication between project stakeholders but being proactive is the only way to maintain control of project costs.
Only Work with Qualified Vendors
Real estate project managers looking to cut costs in the new year definitely need to vet all of their vendors thoroughly. Choosing service providers based on the size of their bids, name recognition, or positive past interactions is a recipe for disaster.
This summer, Northspyre commissioned NewtonX to survey project managers across the country to understand their pain points better. The completed study revealed that 62% of participants struggle with keeping their projects on time and on budget. Respondents expressed concern about the issue regardless of the property types they work with, their location, or the size of their employers. Moreover, the survey showed that a leading cause of poor outcomes is excess change orders.
Signing on to manage a complex real estate project with the expectation of encountering no unexpected budget changes unrealistic. The volatility of the post-pandemic landscape means there's an increased risk of running into on-the-ground financial challenges.
But around half of our survey’s respondents encountered situations where a series of expensive change orders followed a low bid. And 61% of the project managers agreed that vendors most commonly submitted change orders because of “unforeseen conditions at the job site.” Only 30% of the participants named inaccuracies in budgets, designs, or contracts as drivers for service provider claims.
Based on our findings, it’s clear that real estate development professionals could be more selective about their partners. By creating a budget based on potentially misleading data, you set yourself up for a lot of headaches and disappointing project outcomes. However, you can address the issue by maintaining and accessing a database of institutional knowledge made up of historical information from past projects.
With that data, you’ll have insight into your prospective vendors’ past performance and be able to make data-driven procurement decisions. And working with service providers, you can depend on will go a long way toward maintaining project stability.
Track Project Expenses Using a Single Source of Truth
Another effective way for project managers to gain control of their budgets is by tracking their expenses and milestones with a single source of truth. The term refers to the practice of an organization storing and updating information in one place instead of different individuals and departments keeping their own records. Using a single source of truth is usually beneficial to companies because it eliminates the problem of utilizing and inevitably correcting inconsistent information.
For real estate development professionals, a single source of truth offers an even more significant benefit: real-time project visibility.
Creating partner agreements with language that limits potential exposures and thoroughly vetting prospective vendors are important steps to achieving cost control. But since complex projects involve hundreds of service providers over their lifecycle, keeping track of all the relevant contracts, milestones, and change orders become incredibly complicated. Overseeing project costs becomes even harder when a firm’s development and accounting teams use separate systems that contain conflicting information.
If an expense-related document slips through the cracks, project managers can only be reactive, reallocating funds as quickly as possible to avoid serious budget problems. Unfortunately, there’s only so much you can do to resolve a bad situation after it unfolds.
On the other hand, firms that operate with a single source of truth don’t have to deal with that problem. Modern software lets companies track project expenditures and milestone completions through one cloud-based database. In addition to eliminating documentation inconsistencies, purpose-built platforms can give you real-time visibility into your project’s progress. And their automation and artificial intelligence features can give you a proactive warning if a budget line is trending over its commitment.
The proactive warnings provided by best-in-class real estate development platforms can be a huge advantage for developers. Instead of having to rely on gut instincts, leaders can review automatically generated anticipated cost reports (ACRs) to resolve potential overruns before they happen. ACRs offer granular insights to help you maintain cost and budget control and run different development scenarios.
For example, let’s say you find out the material you planned to use for the floors in your hotel project has tripled in price. Modern intelligence software will let you see how that added expense will affect your budget several months into the future. ACRs can also show you how certain value engineering decisions, and money-saving changes made to your building design, will impact your budget. You could discover that swapping out your original flooring choice with a visually appealing but more affordable alternative is the most cost-effective way forward.
Because so many macroeconomic headwinds are overlapping, 2023 will be an especially challenging year for the commercial real estate sector. But you can set yourself up for success by changing their methodologies in anticipation of entering a more volatile landscape. Want to learn more about the conditions you can expect next year? Download our Biggest Challenges & Opportunities Facing Commercial Real Estate Project Managers in 2023 report.
Tag(s): Real Estate Technology
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