By Ken Semler, Publisher, iMedia Group LLC
Construction professionals can tell you what a square foot costs to the penny. Ask what a month costs, however, and they go quiet. Builders and developers spend a lot of time comparing bids for labor and materials to get to that cost per square foot but is that what matters most? Often, the answer is no.
A project that goes on past its scheduled completion date can lose hundreds of thousands, or even millions, of dollars. Then why does that number never appear in bold on the pro forma when comparing traditional to offsite construction? We’re very good at estimating buildings, but very bad at estimating time.
So, what is one month worth? That depends: Is it a month during construction, or a month of stabilized rents? During construction, the month represents interest carry, general conditions, insurance and project management. After completion, it could represent faster home sales or stabilized rent.
According to McKinsey & Company, the average project runs 20% behind schedule. That works against you in two ways: You have more interest carry and general conditions to cover, and revenue is delayed. If, for example, you’re building seasonal rentals like vacation cottages, being three months late is the same as being a year late.
Start rethinking what a month is. It’s more than a block of time; it’s a financial event! An extra month doesn’t just add cost; it delays revenue. But the people doing the financial comparisons have gotten intellectually lazy. They don’t create models that challenge traditional building processes, and the models they do create punish offsite. Why? Because those models don’t accurately reflect, or trust, offsite’s time savings.
Rather than doing a full analysis, they reach a point of perceived parity in the pro forma, the finish stage, and declare that offsite construction will cost $X per sq. ft. more. Stopping here protects the status quo, but again, it’s lazy thinking. Instead, let’s take the analysis to its true end. Let’s get to the Sensitivity Analysis or Scenario Analysis tab on the pro forma workbook.
Consider a $60M project with $175,000 in monthly carry and $350,000 in monthly stabilized NOI (Net Operating Income). If a project is scheduled for 15 months with traditional construction and we use McKinsey’s estimate of a 20% delay, it’s actually an 18-month project. Using simple math, 3x $175,000 for the schedule extension and 3x $350,000 for the delay in getting to stabilized NOI means that traditional construction adds $1.6 million in cost.
What is one month of schedule worth? In this case, $175,000 in carry and $350,000 in NOI = $525,000. But if we used offsite construction for that project, it could be managed and delivered in 10 months. That’s an extra $2.6 million in the owner’s pocket if you assume that the traditional build would have been done on time. Factor in the 20% delay we know was going to happen and that number climbs to a $4.2 million swing.
The industry needs to stop talking about schedule only as a construction issue and start discussing it as part of the investment decision. Cost per sq. ft. isn’t the whole story when comparing building methods. The winner isn’t necessarily decided by who builds the cheapest; it’s the builder who converts capital into a performing asset the fastest. So before asking what your next building costs, ask a harder question: What is one month worth?
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