How do you size contingency when the framing bid is only firm for 21 days?

Question

Work through a spec build with these numbers. Lot at 180k, a 2,400 square foot plan, best hard cost number at 165/sf so call it 396k. Soft costs penciled at 55k. That is 631k all-in before interest. Comps in the pocket run 770 to 790 for similar new construction, so use 780. Construction loan quoted at prime plus a spread, roughly 9.5 percent interest only on the drawn balance, 13 month term. The problem: two of the subs have written escalation language into their proposals, and the framing bid is only firm for 21 days. A builder with years on job sites can smell a soft number, but carrying the money risk personally is a different skill. How should contingency be sized against a budget where the material line can move after the contract is signed? Is 5 percent of hard costs a real number, or is it the number people write to make the lender happy?

Rena Expert · Accepted Answer

Run the carry before you decide whether 5 percent is enough. On 396k of hard costs drawn over 13 months your average outstanding balance is typically somewhere near 55 to 60 percent of the total, so call it 230k at 9.5 percent for 13 months, roughly 24k. Selling costs at 6 percent of 780 are about 47k. That leaves 780 minus 631 minus 24 minus 47, so around 78k on a 631k basis, call it 12 percent of cost across maybe 15 months from acquisition to closing.

Against that margin, 5 percent of hard costs is 20k, a quarter of your profit. That's the honest way to look at contingency. It isn't a lender formality, it's the slice of margin you've already spent. If your escalation clauses pass material increases through from dollar one and residential material prices keep running above 3 percent annually, a 396k hard cost budget absorbs 12k of drift before anything goes wrong on site.

The assumption carrying this deal is the 780. It's a comp from today applied to a closing 13 or 14 months out, in a market where mortgage rates are expected to ease slowly rather than drop. If your buyer pool is rate-sensitive at that price point, a 20k miss on exit and a 20k miss on materials together erase half your margin.

Two things you haven't raised. Draw funding lags inspection, so you personally float the gap between paying subs and getting reimbursed, and that float can run 30k or more at peak. And your lender will order a completion appraisal, so if the finished value comes in under the 780 you underwrote, the buyer's financing is the thing that breaks, not yours. Buy out the long lead packages early and get supplier price holds in writing, including what the hold costs you.

bmoreno23 · Answer

What does the escalation language usually say in practice? Does the sub eat the first few percent or does it pass straight through from dollar one?

sonia_alvarez · Answer

On the lender side of this, most construction budgets that get through underwriting carry a contingency line of 5 to 10 percent of hard costs, and the lender treats it as part of the loan amount rather than free money. Reallocating out of it usually needs written approval. Also ask whether your interest reserve is funded inside the loan or paid monthly out of pocket, because at 9.5 percent that is the difference between finding 2k a month and not.

omar_haddad · Answer

Watch your allowances. Every allowance line in a spec budget is a decision you've deferred, and deferred decisions cost more than scheduled ones. Tile allowance at 4/sf becomes 9/sf the moment somebody stands in the room and looks at it, and if you pick up a buyer at framing stage they will start asking for changes that don't add a dollar of appraised value. I'd rather spec everything cheap and firm than carry twelve open allowances into a 13 month build.

How do you size contingency when the framing bid is only firm for 21 days?

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