Change Orders: Stop Leaving Money on the Table
Construction change orders are a fact of life on residential projects for a multitude of reasons. Like client's change requests on finishes, fixtures, and design; market demand affecting material costs; availability of trade partners, and unexpected site conditions.
And all these situations can impact the original contract price and, in turn, your bottom line if you're not managing them properly. That means using change orders in your remodeling business to capture the project changes that invariably crop up during a remodel or a custom build, adding them to the overall project cost.
What is a Change Order and Why Do They Happen
A change order is an amendment to a construction contract that changes the remodeler or custom home builder's scope of work. We use change orders in the construction industry to ensure that we aren't diluting our profits by covering extra work that are job costs. That typically involves adding both additional time and cost to the overall project budget.
Changes in original scope will occur for a variety of reasons - no matter how accurately you've estimated the project during pre-construction and how well you've tried to anticipate all the potential issues your team may encounter during the build.
What are the Most Common Reasons for Change Orders
While there can be many different reasons for requiring change orders during construction projects, we can break down the most common reasons for issuing them into four categories:
Site Conditions
Engineering or City Inspector Requests
Client Requested Changes
Economic or Workforce Changes
Let's explore them briefly:
Site Conditions
It's not unusual to encounter latent site conditions on a job site right after the demolition phase that changes the project's scope. That's when you and your team get a chance to "peek behind the curtains" and see what's been hiding underneath all the finished walls and floors. This is where you might find things you weren't expecting requiring extra work and where you could need to add additional time and additional compensation to the contract price.
Site condition changes aren't limited to remodels but can also occur during the excavation phase of a new build, where issues like latent soil conditions such as buried fly ash requiring remediation before continuing with the build. Something like this will extend the completion date and add additional cost to the original contract.
Engineering or City Inspector Requests
Despite doing your best to reasonably estimate and account for reports, inspections, and approvals needed for the build, an engineer, city inspector, or other involved parties might often have additional project requirements you didn't anticipate. That involves extra time, material, trades, and consultants being brought into the project, which, if not accounted for via change orders, will come off your bottom line.
Client Changes
This is the big one that will likely drive most of the change orders on a project. I've yet to work on a remodel or custom build where the original scope of work wasn't added to, deleted, or modified in some form by the client.
Whenever you have to pivot away from the original plan your clients agreed to, you're going to end up spending additional time doing behind-the-scenes work, like coordinating with vendors and trades, pricing out materials, and adjusting the project schedule. That, along with the additional costs for materials and labor to execute project changes, is billable time you could be charging to other revenue-generating projects, and it's the fastest way to bleed money on a project if you aren't capturing those costs via a change order form.
Economic or Workforce Changes
During the pre-construction process, you're bidding components of the build to your trade partners and assigning material costs based on the current commodity pricing. But a lot can change between this phase and the point in time when you're hiring your trade or actually purchasing the material.
A trade partner's schedule might have shifted, and all of a sudden, they are not available for the work, or their project scope has changed from our assumptions during the pre-construction phase.
As well, material costs can be volatile. Take lumber, for example. Soft lumber trades as a commodity and the price for it changes daily - which means the price you quoted at the start of the project could be significantly different from the price when you actually purchase it.
Those additional costs are NOT your responsibility to absorb.
Charge for Your Time to Explore Change Orders Too
Regardless of whether you operate as a fixed-cost or cost-plus builder, the time you spend creating change orders falls outside the original cost you've quoted to your client. So if you're spending additional time working on change orders, it's critical you get paid for it.
There's a lot of work that happens in order to properly capture the additional time and costs for even minor changes, and this is billable time. It's also important to think about how many pricing exercises you might do for the owner and the designer on the project that they don't opt to proceed with.
Here are ten reasons why you need to charge for your time:
Identifying the scope of work through conversations with clients, trade partners, and professional partners.
Communicating the change in scope from the original plan to project managers, trade partners, and vendors.
Chasing down answers and pricing from trade partners and vendors.
Verifying that the pricing and scope match and is clear with your trade contractors and vendors.
Preparing the change order to present to the client.
Managing back-and-forth conversations, answering questions, and revising the change order.
Creating the final change order for owner approval and sign-off.
Communicating approvals to trade partners and vendors for the project changes.
Updating the project schedule and reaching out to other trades in the queue to advise of project delays.
Updating project financials and communicating with your accounts person to ensure all the information is captured correctly.
How to Use a Change Order
If you've read this far, you're likely on board with the idea of using change orders in your residential construction business to ensure you're not bleeding profit, but you might be wondering how you can incorporate them into your overall process.
Here are seven best practice steps to get you started using change orders in your remodeling business:
1. Talk about your change order process upfront
Clients don't like surprises any more than you do, so talking about your change order process early sets the correct alignment between you and your clients, so they aren't shocked when you present them with one.
Build it into your upfront sales and pre-construction processes so that talking about it becomes as second nature as talking about tile selections or paint colors.
In doing this, also advise project owners that they should be budgeting for at least a 10% amount above the contract price for changes in the project scope. I don't recommend carrying that contingency in your contract price, but ensuring they have access to these additional funds is critical to setting the right alignments from the beginning.
If you want to hear more about Contingencies vs. Change Order, click here.
2. Do them early and often
Clients don't like the sticker shock of getting invoiced for a whole bunch of additional work at the end of a project when they've already committed so much financially.
Instead of leaving the "extras" for the end, issue change orders as each proposed change comes up. You'll avoid uncomfortable client conversations about project costs later on and ensure you're not left on the hook for those additional costs.
3. Don't miss out on project costs
Use your project estimate as a guide when filling out change orders to ensure you capture ALL the direct costs associated with change requests, from the extra month of toilet rental to site supervision and beyond, so that you're not eating into your profit to cover them.
This is one of the most common profit bleeds I see in construction businesses that are issuing change orders, so it's critical that you think of every "connected cost" to the change on the project and include them in the change order form.
4. Charge for your time as well
As mentioned above, a lot of work goes on before a change order is even written, like sourcing product options, speaking with vendors and trades, pricing out the work, and adjusting the schedule to accommodate those changes.
Change orders need to reflect the additional time you've spent preparing them - because that's time you could be spending on another billable project.
5. Charge the right mark-up
Being a compassionate "good human" is natural when working with clients who are spending their life savings on their construction projects. But this line of thinking can stop us from properly compensating ourselves and our businesses by not charging a markup on extra work or requested changes.
In fact, I recommend charging a higher markup when proposed changes come up during the project because it creates a reduction in your overall throughput for the year. We want clients to be happy with the finished product, but it's also important to respect that your business has overhead and profit to make.
6. Institute a minimum fee
Clients and Designers love to ask the question: "How much do you think it will cost to …?". I have one client whose designer asked this question 27 times on a project and only accepted three change orders. And as a fixed-cost remodeler, he spent hours doing the legwork for the other 24 questions without compensation.
Include a clause in your construction contract that states that you charge a minimum fee to investigate any proposed change on the project. It doesn't matter how much you charge, just that you do. So the next time the designer and owner ask the question, "how much do you think it will cost to..." you can reply with, "the answer starts at X dollars."
And most importantly, follow through and charge it!
7. Get a signature
Clients have short memories - especially when it comes to project changes that will increase the cost of their project. Getting their signature on a written change order document or electronically through platforms like DocuSign, BuilderTrend, or CoConstruct is an acknowledgment by the client that they are aware of the additional costs that will be charged to them and the additional time added to the project - protecting you in the long run.
Your Change Order System Doesn't Need to be Perfect at First
The most important thing to remember about implementing change orders is that "done is better than perfect." If you're just starting to use change orders in your remodeling business, don't get hung up on thinking you need to have the perfect system in place first.
It's simply critical that you're actually doing them - and the best system is the one you'll use. It can be as simple as a PDF that you send to a client for electronic signature or a Microsoft Word or Excel (or Google Doc/Sheet) change order form that you print off for them to sign in person.
The trick is to avoid not doing them because you're stuck on figuring out "how" to do them, and you can't move forward until you've implemented the perfect system first. You can tweak your process along the way.
Even if it means a short project delay while you're gaining the required approval, you'll be far better off than doing the extra work and then having a hard time collecting later on from the owner.
The Bottom Line
Despite all of the upfront work you might have done in the estimating phase of a project, things will happen during the construction process that needs to be accounted for in the overall budget to avoid profit bleeds and reduced cash flow.
These are costs you're going to have to pay, which means you need to issue change orders to pass those costs on to your client and ensure you aren't funding them from your profit.
Having a conversation about executing change orders may feel uncomfortable, but not nearly as uncomfortable as not being able to run a profitable remodeling business that supports your family and rewards the team that's worked hard for you all year with a well-deserved bonus.
If you're looking for more information on implementing a bullet-proof Change Order Process, click here to book a time to chat about the Build and Profit System.
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