Most of the time, the construction of an architect-designed project proceeds according to plan. Construction unfolds on time. The construction documentation is clear and free of ambiguity. The trades perform their work skilfully and conscientiously. There are few surprises, be they physical or financial. The builder, owner and architect maintain a positive working relationship.
Sometimes though, construction does not proceed according to plan. Through negligence, disagreement or accident, a project is derailed. The derailment might last a moment in time, soon forgotten, or it might endure the entire project, poisoning both the process and relationships.
We have experienced and survived a number of derailments. They are stressful, sometimes expensive and always fractious. They test the good intentions of everyone involved.
What follows is the 2nd of eight disaster lessons from site. We ask what went wrong and review what we’ve changed in our practices to prevent it from happening again. An archive of the series can be accessed here.
2. Progress payments by stage
It is typical for a builder to claim payments for his work on a monthly basis, where the sum claimed corresponds to the value of the work undertaken in the past month. The builder instead requested that payments be made by stage. This involves regulated percentages that can be claimed at the completion of stipulated stages of construction:
Base stage – 10%
Framing stage – 15%
Lock-up stage – 35%
Fixing stage – 20%
Completion – 20%
Staged payments are larger but less regular than monthly payments. We recognised that this request likely related to the builder’s aversion to paperwork, but were unable to see any problem with it, so accepted his request.
What happened next
After the first few months of construction had passed, it became clear that the staged payments were a problem for the builder. They were simply spread too far apart. He might not have liked the paperwork involved with monthly payments, but the stop-start cashflow really hurt him.
This had two important effects:
First, he began to disappear from site for weeks at a time. Though the builder refused to provide explanations for his absences, we suspected he was taking on smaller commissions with fast turnarounds to keep the money flowing. These periods of non-activity on site stacked alarmingly, stretching what was supposed to be a nine month construction period out to 18 months.
Second, in order to reduce the money he would owe subcontractors, he began to take on specialist trades like concreting, plastering, plumbing and hydronic heating himself. He had to redo many of these, as his workmanship was not up to an acceptable standard. He also made errors that were impossible to rectify, things like bootprints in finished concrete surfaces and hydronic heating lines emerging crookedly from concrete slabs.
Why we think it happened
Though the builder never came clean with us or our client, we had no doubt that he was struggling financially. If the project had proceeded according to schedule, he would have received his staged payments once every two months or so. As the schedule stretched further and further, there were times when four or five months passed without payment. The poor cashflow created a vicious cycle that stretched the project timeline and impeded cashflow further.
The builder was not capable of extricating himself from this cycle. He had dug his own hole and everything he did, in terms of both his poor scheduling and inattention to quality, only served to make the hole deeper.
The lesson we learnt
This experience was powerful proof of the importance of cashflow on site. Consider: on a $500,000 project, the builder’s profit margin is around 15%. In other words, he pays and receives $425,000 in order to earn just $75,000. He also has to pay suppliers and subcontractors before our client pays him, the gap between which might be as much as two months. He must therefore keep the money coming in or the cycle will disintegrate.
The lesson we learnt was simple: we no longer accept project payments by stage. Even if the builder is paperwork-shy, and we must produce additional paperwork to compensate, we insist on monthly payments.
- Progress payments by stage, author’s own image.
Thanks for the post. This sound like a error of inexperience from the builder. For most smaller residential project here in NSW are run as staged payments. My hunch is that this builder may have more experience with smaller quicker projects where this staged progress payments actually plays into the hands of the builder where they can at times make 2 claims within the month thus getting a better cashflow situation. I have seen this happen to builders using staged progress payments on a larger $900k project. I also suspect in his case he also under priced the project. You mention 15% margin, I would have thought that this is also a little thin on a 500k project. I have usually seen 18-20% at this price level. Of cause this may only end up as about 15% or less if not managed well. I wonder if the builder also ran into issues of under pricing the project, again indicating lack of experience.
Thanks for your comment, David. I think in this scenario that you’re right. He never said so, but I’m certain he underpriced. The issues were all wrapped up together.