The Basics of Reallocations and Change Orders

Construction projects are complicated endeavors with numerous participants and processes. This is why it's nearly impossible to predict the exact amount of costs involved. Regardless of the amount of time and attention dedicated to budget planning, no matter how big or small your construction project, you will likely deviate from the initial plan. That’s where change orders and reallocations come in.

Change Orders

A change order is a term used for an amendment to the original construction contract. It addresses any changes outside of the scope of the contract that arise during the construction process, whether they are changes to the scope of work, materials costs, or contract terms.

Change orders don’t necessarily arise from poor budgeting and planning, or any errors made during the construction process. They are sometimes caused by events outside of the control of any of the involved parties, which can vary from market conditions and labor costs to weather conditions and other unforeseen circumstances. Sometimes change orders can reduce costs, if the changes in question require less work, fewer materials, or materials of lesser value.

In general, though, change orders bring about additional costs, so they're heavily negotiated between the capital partner and project owner. It's in the capital partner's best interest that the construction costs are covered by the loaned funds. Before any additional funding is approved, the capital partner and owner will first look to see whether any funds can be shifted between different line items in the project. This process is called reallocation.

Reallocations

Reallocation is the transfer of project funds from one line item to the other. Since change orders are so common, loan agreements often include contingency funds in the budget designed to address change order scenarios. In case of a change order, the funds will then be reallocated from the contingency funds to the line item(s) defined by the change order. Ideally, these funds will be sufficient to cover the additional costs of change orders.

Negotiating the terms of reallocation is one of the touchiest aspects of the loan agreement. Naturally, the borrower will wish for more flexibility in the use of contingency funds, while the capital partner will wish to maintain a great degree of control over how the funds are used. In order to ensure that the contingency funds are not exhausted before the project is completed, the capital partner will sometimes tie the amount of contingency funds approved for a change order to the project’s completion percentage. In other words, the capital partner will only approve the percentage of the contingency funds equal to the percentage of completed work.

A loan agreement should be comprehensive and meticulous in its realistic assessment of the project’s total budget, including the anticipation of changes to the project and detailed mechanisms for addressing these changes.

How to Minimize Change Orders

Change orders are almost inevitable, but there are steps that can be taken in order to minimize the number of changes necessary for the project’s completion. It all comes down to being meticulous in considering all the predictable aspects of the project.

A realistic assessment of the project’s total cost should be performed and should not only include the construction work but also all accompanying costs (safety measures, material storage, insurance, taxes, etc.) The project location and its natural suitability for the project should also be under scrutiny in order to avoid any potential problems further down the road. Contractor bids should be evaluated for quality before making a selection.

You should also ensure a clear line of communication between all involved parties. Mistakes often arise from misunderstandings and lack of complete information, and it's essential for the project’s success that everyone is on the same page. Communication and planning go a long way in minimizing the change orders involved in a project.