Real estate developers have lots of options for structuring their companies, as the laws in the United States promote the ability of multiple smaller companies to be involved in these large scale construction projects.
However, with more and more developers choosing to self-perform as their own architect, engineer, or general contractor, combined with the emergence of design/build firms, and self-performing general contractors the traditional method of development is changing. Here we will explore the new options open to developers when selecting a general contractor for their project.
Real estate development is a massive undertaking, requiring a carefully curated team of experts in a variety of fields. Traditionally, a developer begins a project by assembling a large group of professionals, each specializing in a single component of the project. The main parties involved have their own internal team to execute their tasks, while the General Contractor’s team is also responsible for managing 3rd parties suppliers as well as subcontractors. Historically, the structure looked like this:
As you can see, the developer is responsible for directly managing many parties which is difficult, time-consuming, and stressful. In order to decrease the number of people directly reporting to the developer, a new type of general contractor has sprung up:
The Design/Build Company
In this model, the design/build company takes on the role of the General Contractor and more. They also are in charge of the designer/architect as well as the engineering team, thus decreasing the number of entities directly reporting to the developer. The value proposition here is threefold.
First, as a developer, you have two fewer parties to directly manage. Second, you eliminate the disconnect between an architect’s design and what it takes to actually build it. By having these parties all under one umbrella, the architects, engineers, and builders are all working together from the start, ensuring that the design can indeed be built to the budget and timeline specifications.
You save time and money by eliminating the possibility of having to rework an impractical or unfeasible design while (and this is the third value proposition,) simultaneously selecting materials that best meet your project objectives for aesthetics, practicality in construction, functionality of the finished product, project timeline, and budget.
If relinquishing direct control over the designer/architect and engineering teams is not appealing to a developer, a more appealing option might be to select:
A Self-Performing General Contractor
In this model, the general contractor does not hire subcontractors to do the actual work. Instead, the work is done by their own in house team.
The benefit here is also trifold. First, general contractors with direct employees can hold those employees to a higher standard than their subcontractors. They have the expertise and ability to evaluate and train on-site, and having direct control over employees enables them more control over scheduling, labor volatility, and construction site safety. Second, they can adapt to unforeseen circumstances on the fly, shifting resources immediately in order to maximize the productivity of their crews in real-time. Third, they fully understand the skill level of their team, eliminating costly mistakes encountered by unknowingly hiring unqualified subcontractors and they can push their crews to the optimal level that they can maintain.
“As a seasoned and sophisticated company, we are going to save you money at the end of the day because we do this for a living. Our clients are paying for our expertise, our relationships, our leadership, our standards of quality and service, and our in-house team.”
– Denis Koval, CEO, Kapella Group
Knowing how to build a structure is not the same as knowing how to form and operate a development company, which is why the General Contractor historically has played a critical role as a main component of the team. However, a new model has recently appeared where:
Developers Self-Perform as the General Contractor
The value proposition pitched is that self-performing everything is the most efficient way to decrease project timelines and saves on costs. By having total control over a project, the developer can be directly involved with the procurement of materials, overseeing the construction site, and selecting subcontractors. They can also avoid any messy litigation that could arise should there be a disagreement between themselves and the general contractor. However, this model has hidden costs as well.
The management and procurement of materials traditionally rest in the hands of the general contractor. As a self-performing general contractor, large developers may benefit from being able to buy materials in bulk for multiple projects happening at the same time. However, the trade-off is losing the material procurement skills of a seasoned general contractor who will be more adept at choosing the best-suited materials for the project, sourcing the right equipment for their installation, and mitigating supply chain issues from the start.
In models that include a general contractor, the liability is transferred off of the developer and onto the general contractor, as general contractors must be licensed, insured, and in some cases bonded as well. They must ensure a safe work environment and are the ones held accountable for any accidents that occur on-site. If a developer is unfamiliar with best practices here it could prove disastrous both financially and for their reputation. A single accident could result in higher insurance rates for the developer, and a tarnished record could make securing financing for future projects increasingly difficult.
Eliminating a general contractor means that self-performing developers must work directly with subcontractors. Having direct contact with subs can be beneficial in relationship building and cutting out the middleman can provide a sense of security for the subs when it comes to payment. However, it also puts an added strain on the developers as they are not able to benefit from the long-standing relationships that general contractors have with their subcontractors. The time spent finding, vetting, and managing subs is often more than anticipated and the time and cost of having to make up for mistakes made by unqualified subcontractors can pile up.
“I worked on a project for a developer who self-performed for the first time. It was disastrous because their team was not experienced at acting as a general contractor and didn’t know the ins and outs of managing subcontractors. They tried again a second time, which proved to be a little better, but ultimately, they decided to return to hiring general contractors for all future projects”
– Project Manager, Electrical Subcontractor
If economies of scale provide a benefit for material costs, they can cause problems when it comes to the type and volume of projects a self-performing developer can take on. Drastic fluctuations in the amount of construction staff required at any given time make it difficult to run an efficient payroll. Furthermore, retaining staff who at one moment may be overloaded and the next out of work is next to impossible and is one of the biggest challenges facing self-performing developers.
Finally, branching out into something new brings scrutiny in any market. Lenders especially like to see a historical track record of success and may not be willing to take the risk that comes along with backing a developer who is just starting to self-perform. This confidence is further eroded because budget responsibility is no longer something clearly agreed upon between the general contractor and the developer. When developers self-perform they are not as quick to recognize and adapt when they are off-budget and they can more easily disguise cost overruns.
We will no doubt see more hybrid models spring up and adaptations to the role of a general contractor continue as the construction industry continues to grow. Which models will stand the test of time? That’s an answer yet to be discovered.