Developers: GMP & Change Orders
I work on the LP side and we are the money behind various developments. That means I know diddly squat about how things work on the GP/Developer side and even less on the technical aspects of construction.
It seems that my firm gets comfortable with doing development deals because we have guaranteed max price (GMP) built into our contracts with the general contractor. Maybe it's just me, but it seems like the GMP holds very little weight.
- Rainy day, can't do work? Change order, added cost.
- Architect messed up a drawing? Change order, added cost.
- Delayed permits, can't do work? Change order, added cost.
I would think a GMP is a transfer of risk from the owner to the general contractor (as they are compensated more for a GMP), but this doesn't appear to me the case.
As a clueless LP, can someone fill me in on the nitty gritty of how this actually works?
So, there are other means of contracting other than GMP, but I'm not even going to try and explain all that (not really my strong suit anyway).
Just think about your above statement, if you contract to transfer all the risk to the GC, who is out to make a 2-3% profit margin on the value of the contract, just imagine what they would have to charge you!!!! That does occur (gov't work sometimes), but you are basically making the GC a developer and then buying the building at value at that point.
GMP really only controls for "controllable", the "un-controlled" stuff, like the examples you give, are the risk of the developer most of the time. The architect one is the most crazy imho, and why people sometimes want design-build or more "integrated" contracts (in short, this is "controllable" in my opinion, but you may need to pay more upfront to the architect, engineer, and pre-con team to really de-risk this, which some developers get cheap at tbh). Again, the more you "de-risk" yourself, the higher the GC charges you upfront, but developer can control some of this (but at a cost). Trying to be cheap (or too fast) on design causes a lot of these issues, and sometimes waiting for 100% CDs is not efficient from a time perspective (i.e. pick your poison.... a cost over run, or extra months until TCO?).
Either way... welcome to development, this is part of the life!
Really the only risk you're transferring is pricing risk. Which can be significant. Lets say to get a new construction process finished from the first shovel in the ground to the last item on the punch list, it takes 24 months (hint: it can take a lot longer with only small delays). Well, the price of a lot of materials and even labor can change massively in two years. So you do protect yourself on that front.
Moreover, some of the stuff you're talking about isn't really governed by the GMP contract. Like... rainy day delays - to the extent you even have that, it should be governed by having LDs for running over schedule. Any good GC should be building in scheduling contingency, and rain really only hurts when you're trying to pour concrete (and SOE, I guess).
As for the rest of it - why should the GC eat the cost of a mistake by another member of the development team? Expeditors and architects are responsible for permits and plans. Contracts should spell out what a GC's responsibilities are when it comes to getting or assisting with pulling permits.
This is all just part and parcel of how little folks, even those in the industry, understand the risk profile associated with development, and why it requires such a wide range of skills beyond "I can make an excel model."
All these contracts vary. You can definitely sign a contract that puts all the risk on the GC...but you will be charge a massive markup plus your unborn child as a bonus. It makes much more sense to make sure you have your ducks in a row in order to minimize change orders.
As with most things, control, risk, and reward go together. redever is right, the GC is set to make a fraction of what a developer should make on a successful project, so your GC is willing to sign up for some risk but only for things within their control.
The GC doesn't control the weather, so they deserve an extension and/or compensation if they can't work. We mitigate (read: we prepay for) this by including a set number of weather days that are already priced into the GMP and carried in the schedule. We only accept a change order if the cumulative weather days reported exceed the contracted number -- depending on construction style, construction duration, and location, this might be 10-30 working days in our standard contracts.
The GC didn't design the building, they shouldn't come out of pocket if the architect didn't properly coordinate MEP drawings with structural, or didn't follow local code properly, or didn't think to include wall coverings in the elevator lobbies, etc. Certainly a strong architect helps to avoid too many of these issues, but we also look to team up architects and GCs that have experience together on similar projects. We also require our GC to be heavily involved during pre-con (typically we require our GC to provide the service as skin in the game to keep all motivate to get to the closing table), this helps direct the design to an acceptable solution by providing real-time pricing feedback rather than spending weeks/months designing then realizing the budget is out of control and needing extensive redesign work, it also helps to identify trickle-down impacts (schedule and cost) of design changes that the architect may not immediately consider, and provides the GC with more context on the project vs having them blindly price a set of documents without the intimate background knowledge to go with. This is where a developer is going to spend a portion of their contingency on every project, there's no such thing as a perfectly designed building.
The GC doesn't control the bureaucrats or their often painfully slow approval processes, nobody can truly control this, and why it is typically a risk owned by the developer. We try to avoid this risk by having all necessary critical-path permits in-hand (or just waiting for payment) prior to executing a GMP and commencing construction. TCO/CO is different and is typically owned by the GC.
Developing is a balancing act. Mitigating every potential risk upfront takes time and money and it may end up being unnecessary, but those things that end up being an issue and that you didn't plan for ahead of time, will end up being more costly down the road. An experienced developer is typically better at knowing where to spend extra money early and which items can be addressed with contingency if/when they become an issue.
Very well said. This guy builds.
Guessing your architect forgot this recently lol
The GMP is only the instrument to facilitate the buyout procedure for the contract. In a GMP agreement, a gross maximum price is specified and a final contract value is whittled down over time based on the incremental buyout of different trades/subcontracts on an "open book" bid leveling process as the project matures over time. GMPs usually contain a shared savings clause to incentivize the GC to obtain the most competitive pricing (ie, if a buyout occurs below the GMP subcontract value, those savings are subject to an owner/contractor split). Conversely, a lump sum contract specifies an exact price for the job--the contractor has more risk/reward in the sense that if they can build the job to the exact specifications in the drawing for cheaper (having more flexibility to hire certain subs at their discretion), they pocket 100% of the savings. This structure is usually cheaper for the owner but less collaborative in the sense that there is less information sharing, and more incentive for the GC to take shortcuts to complete the job more cheaply.
With respect to the construction curveballs referenced in the original post, those are the responsibility of an experienced owner/developer to negotiate as part of the contract process. Most AIA GMP agreements include a specified number of weather days built into the contract as a "weather bank"; a Clarifications and Qualifications exhibit clarifying exactly what is in and out of the pricing, outside of the basic architectural/civil/landscape/MEP drawing package; specific allowances to cover scope items that may not be in final form/subject to future change; and provisions for liquidated damages that the owner can capture if there are schedule delays the contractor cannot prove were directly the responsibility of the owner.
@ozymandia captured the concept most succinctly in the statement that the contract structure (GMP vs. lump sum, generally) primarily addresses pricing risk.
Only problem with the cost savings structure (although I know thats market) is the GC usually cheaps out on something different than what's on the plans, and you never get what you intended. Has happened too many times.
Question about cash flows on a project with a GMP. We're well along in construction now and have all of the major sub trades locked in, achieving a decent amount of buyout savings compared with the schedule of values in the GMP contract. Per the contract, the GC gets a portion of those savings.
We also have some upcoming change orders, the total of which exceed our contingency in the GMP. However, the buyout savings are significant enough that [GMP (inc contingency) - Owner Share of Buyout Savings + Change Orders = less than GMP]. So we're still in the black by a decent amount. Anything could happen, but we're far enough along on a cookie-cutter new build that there should be limited additional CO exposure.
The issue is that we have to pay for the COs in the relatively near future, but theoretically we can't access any of the buyout savings until the end of construction. So we have a cash crunch and will need to fund more into the deal, even though the overall projected cost of the work hasn't increased.
We'll do what we need to do, but I'm curious whether people have had success with realizing the buyout partway through. If we could shrink some of the line items in the schedule of values and reallocate the excess to the change orders, we wouldn't have to pull in more equity.
Yes, if we did this, there would still be a chance that we'd have additional COs and need to pull in more equity anyway. But that's only a possibility, whereas, under the current circumstances, we would definitely need it.
Responding to myself as I continue to think this through. The reason to go through the exercise I described above would be that the construction lender wouldn't fund the change order costs in a draw, since those costs are not part of the GMP. So we would allocate the buyout savings before completion to keep the GMP number from climbing.
I suppose an alternate route, if the bank would accept it, would be to give them all of the signed subcontractor contracts to show them that the buyout is complete and the actual project cost isn't going to exceed the original GMP, let alone the GMP as increased by change orders. Then, theoretically, they could allow loan proceeds previously allocated to those sub trades to be used for the change order costs.
Do you not have Owner's Contingency set aside apart from the GMP?
Yes - always negotiate to get money out early. If you offer to crystallize savings slip they may be more willing to give money back early.
So…the dirty little secret of development - whether you have a GMP or not, all costs eventually fall on the developer. Sure, the GMP will protect you against some thing, but…
The GC only makes 2% of HC. They make the most amount of money on the project on day 1. The second day 2 hits and one change order is issued which is denied, the GCs profit is 2% less the Change Order not accepted.
If costs shoot so high and the GC totally missed the budget, even if the GC needs to pay those costs - it’ll put the GC out of business. Why? Because it comes out of GC profit and they are guaranteeing the price. If it puts the GC out of business…the developer is screwed. This is an unlikely scenario, but explains the leverage in the situation. Eventually, the developer will need to cough up money and it becomes a negotiation between the GC & Developer to finish the project and how costs are split. If the developer loses its GC mid project, it adds tons extra risk.
Which is why developers get paid! Very few people truly understand the concept of risk (or confuse it with opportunity cost). Real estate developers take a lot of it on.
To be honest, I think this is a little misleading. I've never met a GC making 2-4% or whatever, that's just their line-item fee. They're making their money by arbitraging your budget vs what they pay subs. Which is why when prices for labor and materials goes up, you see GCs cutting corners basically everywhere else. They'll hire fewer guys from each sub, because the delay to the project is a cost to the developer but they can save a couple bucks on their contract with the sub. That's when you start to see orders for materials that don't match what is called out on the drawings, or that assume the cheapest possible option available, because they're really hoping to make 10%+ and they're trying to claw back that margin by passing on costs to the developer. Incidentally, this is why you spend an extra couple weeks getting your CDs to 95-100%, or make sure you're dual tracking that in the very beginning of the process, because that will almost unquestionably be the biggest bone of contention in any construction project (in MF, at least). I suspect some of the less scrupulous GCs actually encourage getting started before details are hammered out, precisely because that gray area gives them leverage
GMP + Bond = some indication GC knows what he is doing.
cost inflator
and GCs make way more on jobs than 2%. target is 10% which in it of itself provides a safety cushion. as its gets down to 2% or lower GC comes to the developer with a hand open.
What do you mean by bond?
construction performance bond, an insurance product that says if a GC goes out of business or a sub the insurance co will find someone to fill their job. insurance co evaluate the GC and Subs track record and financial health (balance sheet). shoddy or new companies cant get bonded
The ability to get bonded is a sign of the GC's strength, but (except in public-section construction) it's the owner's decision whether to have the GC actually obtain a performance bond. It's a direct pass-through cost that you, as the owner, have to pay as part of the overall project cost if you want it. The GC probably doesn't care one way or the other.
As others have already noted, a GMP, compared to a lump sum, allows transparency in the subcontractor buyout process and gives opportunities for a savings split between Owner and Contractor. It's name is very misleading if you're not familiar with the mechanics of the contract, and the roles/responsibilities of all parties involved in the project.
To learn the nitty gritty, you can study the details of how each contract works through the AIA website, just google the contract title and go from there.
Could you - or anyone for that matter, since nobody has done so yet - please explain an example of what the GMP would cover as a “controllable” expense and where you’d see benefit in the GMP process as a developer realizing savings from going that route as opposed to lump sum?
Reading the responses here, I’m not sure and would like to know an example of pricing differences you’d see on a hypothetical 100k SF bldg…from the definition everyone’s giving, it really doesn’t make it clear at all why someone would choose GMP or lump sum in favor of either. I just want hypothetical dives into why someone would favor either or to understand better.
Thank you!
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